Share pick for 2020: Luceco
Some of the best investment opportunities are found when fundamentally good companies temporarily come a cropper. This is exactly the case with Luceco (LUCE), which continues to enjoy strong orders and has the scope to repair profit margins from the high single digits of today to the mid-teens of the past.
Having sorted out the disastrous stock and currency mis-management problems of a couple of years ago, Luceco has the opportunity to transform itself and its share price through 2020 and beyond.
There is scope for significant profit margin recovery to around 12% by 2021, improve free cash flow and possibly make value-adding acquisitions.
The Telford-based business supplies a large collection of electrical and wiring products to both retail and wholesale providers, covering industries such as commercial construction, residential housebuilding and housing maintenance.
Perhaps best known for its relatively new LED business (started from scratch just five years ago), many investors fail to recognise its much larger and more profitable wiring accessories operation, trading as BG, which supplies to the likes of B&Q and Travis Perkins (TPK).
This part of the business runs on high-teens margins and produces roughly 75% of operating profit. This is a regulated and defensive market with 50%-odd recurring revenues providing safety solutions to large landlords in both new build and repair, maintenance and improvement.
No-one wants to run the risk of electrocuting tenants when they plug the iron or kettle into the mains, for example.
Luceco’s wiring accessories business is still largely UK-based making international expansion an exciting opportunity.
Now that LED start-up costs have been largely sunk, free cash flow should really race ahead. For example, it threw off roughly £18m of free cash flow between 2014 and 2018. By contrast, analysts forecast £18m free cash flow in 2020 alone. This will allow Luceco to both deleverage the balance sheet and begin making bolt-on acquisitions to power growth.
Luceco is expected to have around £30m of net debt at the end of 2019, but that is forecast to be slashed to less than £5m by the end of 2021, giving the company up to £80m of acquisition firepower.
The stock is inexpensive in price-to-earnings terms, trading on just 12.6 times 2020 earnings forecasts of 9.2p.
With significant profit growth potential from both operational improvements, underlying expansion and acquisitions, we believe Luceco shares have significant re-rating potential.