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DiscoverIE is boosting margins by targeting higher return areas
We like the effort to secure higher value business at electronics engineer DiscoverIE (DSCV). This used to be a fairly simple distributor of parts and components in the industry and today around 40% of revenue still comes from long-run contracts to supply bits of kit.
But that is where the company has come from, not where it is going. During the past few years it has made a deliberate attempt to design and supply bespoke pieces of equipment to highly regulated industries.
Think medical, aerospace, transport and renewables. Equipment includes aspects like blade controls for wind turbines, artificial intelligence-based telematics and connectivity components, sensing and power systems.
It is a strategy that looks sensible and one that, presuming all goes to plan, could prove very profitable for the company and its shareholders. These are sectors where equipment needs to be high-performance, reliable, efficient and regulations compliant, and that should mean increased profit margins and higher barriers to entry.
Because much of its income still comes from plain distribution it means that operating profit margins are starting from a low base, about 6.3% in the year to 31 March 2018, but have scope to rise fairly quickly.
Analysts estimate at least 7% in the current financial year, and on to 8.5% targeted by the company over the next couple of years.
To put that into context, on 8.5% operating margins last year, DiscoverIE’s operating profit would have sailed in at around £33m instead of the £24.5m reported. Encouragingly, margins were running at 6.8% during the six months to 30 September 2018.
Progress is cracking on at an encouraging pace. Organic revenue was up 10% in the third quarter to 31 December 2018.
Acquisitions potentially bring ready-made new clients in suitable vertical markets that also allow a level of cross-selling.
Acquisitions are also likely to help meet the company’s ambitions to grow revenue from outside of Europe.
Dividend forecasts imply a payout of about 10p this year for a decent 2.5% income yield that is outstripping inflation (2.1% at the last ONS count in December). DiscoverIE is also generating lots of cash flow (converting 84% of operating profit into cash), allowing net debt of £62.6m to be paid down over time.
Execution is key and that’s where problems could arise if management take their eyes off the ball, but there has been little sign of that so far.
A global economic downturn could also spell trouble. Yet these risks look priced in on a March 2020 price-to-earnings multiple of about 14.5 for double-digit underlying growth and scope for earnings
to expand even faster.