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Acal's buy-and-build strategy paying off

Last updated: 13:39 24 Feb 2015 GMT, First published: 14:39 24 Feb 2015 GMT

windy

Chief executive Nick Jefferies probably won’t thank me when I describe his company Acal (LON:ACL) as the epitome of solidity.

It gives scant credit for the turnaround enacted over the past seven years and ascribes little value to the buy-and-build strategy that has helped transform the business.

Acal has made nine acquisitions since 2009 and in that time delivered compound annual growth of 19%.

So Acal, a distributor, designer and manufacturer of niche electronics, is not your archetypal plodder.

However, the base business onto which the new operations are bolted is as steady as they come.

It is primed to grow organically two to three percentage points above GDP and is a stock that pays a 3.5% dividend yield.

Solid, unspectacular, but the sort of investment you’d want to cornerstone your equity portfolio.

These are virtues that no doubt attracted its loyal following of City institutions.

The company is expected by analysts to turn over between £272mln and £275mln this year.

Sixty per cent of those sales and 30% of Acal’s profits are generated by the custom distribution business, which taps into a customer base of 20,000 in 12 countries.

The design and manufacturing arm, which produces customised or highly differentiated electronic products, generates the remainder of the earnings.

Almost 80% of its revenues are from outside the UK – so Acal is one of a handful of small British companies doing well abroad.

Most of its sales come from Europe; however, it has grown the US and Asia from nothing to 10% of turnover in just three years.

Investors will be familiar with the likes of Electrocomponents and Premier Farnell -  the industry’s six hundred pound gorillas.

Both sell ‘commoditised’ electronics, whereas Acal’s are bespoke.

“We don’t sell into the TV or Xbox market,” said Jefferies.

“We sell niche, or should I say, customised, electronics to industrial customers.”

For example, the company sources and sells the temperature sensor for the popular Nespresso coffee machine and it is the only stockist of this part.

Its customers also include the aircraft maker Saab and GE Healthcare, for which it makes custom transformers used in CT scanners.

“You have to be certified and highly qualified to get [your parts] into a medical product such as GE’s,” the Acal chief executive said.

“The barriers of entry are very high. It is very difficult for a competitor to displace us because once that product is designed in it stays there for years.”

In January it bought Foss, a specialist in fibre optics, for £10.1mln and last June it spent £73.5mln on electromagnetics products group Trafo Holding, trading as Noratel, raising £55mln from the equity market in the process.

The latter is bedding in well, Jefferies revealed, while both fit the Acal blueprint in being immediately earnings enhancing.

Future bolt-on acquisitions will be funded from debt, while the company will tap the market periodically to fund the larger transactions, the CEO added.

The brokers covering Acal are predicting the group will make earnings before interest, tax, depreciation and amortisation of between £16-17mln in the current year, up from £9mln previously, rising to around £22mln in 2016.

The operating margin is predicted to have grown to around 4.9% in year to March 31 2015 and the plan is to expand it to 6-7% in the next three years.

“Despite a relatively tough macroeconomic backdrop, management has continued to deliver organic growth and margin progression, while completing value-enhancing acquisitions,” said Henry Carver, analyst at broker Peel Hunt.

The shares, up 27% in the last three months, trade on just 14 times 2016 earnings.

It is fair to say this valuation really doesn’t factor in the upside from margin expansion or the impact of the new acquisitions.

Neither does it recognise the opportunity to cross-sell its design and manufacturing expertise to the 20,000 clients on its custom distribution database.

At the same time, the group is detecting an upturn in money supply that usually points to an increase in capital expenditure at firms it works with.

Past experience suggests this normally then leads to a pick-up in orders – albeit delayed by some four to five months

“We saw this trend in 2010 when we had organic sales growth of 30%,” said Jefferies.

“Now, I’m not expecting to see a repeat of that sort of performance, but there does seem to be correlation between M1 money supply and sales trends. So we are reasonably confident going forward.”

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