Supplying components “just in time” means global industrial distributor RS Group can charge a premium for the speed and breadth of products delivered. But it also means the FTSE 100 group is acutely short-sighted over future revenue. As global recessions take hold, investors have become more wary of the group’s ability to sustain sales growth as manufacturing output declines.
Even bullish guidance could not draw more positivity from investors. RS, formerly Electrocomponents, expects profit this year to be at the top-end of the consensus range of £350 million to £375 million. Gaining market share and mitigating cost inflation with higher prices has helped to counter weaker sales.
Still, top-line growth has slowed. An increase in revenue of 8 per cent in the latest three months was almost half the rate recorded over the September quarter. What’s more, price inflation has done almost all of the heavy lifting, up in the low double digits during the quarter.
Fluctuating sales volumes have an outsized impact on RS’s bottom line, stemming from a relatively high level of fixed costs within the business. When organic revenue fell by an aggregate 10 per cent in the aftermath of the last great financial crisis in 2009 and 2010, adjusted operating profit fell by 30 per cent, brokerage Shore Capital calculates.
RS Group has two main sources of weakness: Asia Pacific and the electronics business, which caters mainly to design engineers. Sales in the former fell 8 per cent in the third quarter. Zero-Covid rules in China played a part, as did a shortage of some computing products. Looser rules in China could help to lift sales, but weakness in the electronics business will be harder to shift.
Electronics, which accounts for roughly a quarter of sales, recorded a decline in volumes in the company’s third quarter and a 4 per cent contraction in like-for-like revenue. The business is more closely geared towards capital expenditure budgets, so more vulnerable to a fall in consumer demand.
The shares have fallen by just over a quarter since November 2021 and now change hands at 16 times forecast earnings. Investors are right to discount the shares, without pricing in a doomsday scenario for RS. The core industrial business, which accounts for three quarters of revenue, distributes parts used to repair and maintain manufacturing facilities. The average order size is only £250, manufacturers spend out of operational rather than capital expenditure budgets. That means sales are less closely tied to output, but then it does not completely insulate RS’s sales volumes against manufacturers shuttering production facilities entirely or going bust.
Lindsley Ruth and David Egan, interim boss and former finance chief, have put the business on a better footing to withstand the downturn. An adjusted operating margin of 12.5 per cent last year was double the level in 2015, during which time sales have grown at a compound annual rate of 11 per cent.
Free cash generation has stepped up, with the group in a net cash position. That leaves room for acquisitions to expand its services business, which includes production design and procurement, the “value-add” that RS hopes will give it an edge over rival distributors.
Self-help initiatives, like automating some distribution facilities, and sales price inflation helped RS push its margin forward during the first half of this financial year despite higher wage and logistics costs. The question now is to what extent price inflation will continue to mitigate slowing sales volumes and whether RS will need to rein in spending on growth plans, that include growing online sales and broadening product ranges.
ADVICE Hold
WHY The company is in good financial shape to withstand a downturn but deserves its weaker valuation
Games Workshop
Games Workshop is burdened by its past glory. A boom in sales at the fantasy figurine maker during the pandemic has given way to a slowdown in global growth rates, compounded by a rise in the costs of raw materials, labour and transportation.
Pre-tax profits fell 5 per cent in the first half of its financial year, albeit in line with management guidance. Hobbyists are loyal but not above the wider strains on disposable income. But note that analysts at Panmure Gordon expect sales and pre-tax profits to edge ahead by 10 per cent and 4 per cent respectively this year. The release of a new edition of Warhammer 40,000, one of the group’s two core products, could be due this summer, the brokerage believes, and that could provide another boost to sales.
The company’s market value has rightly come down from the pandemic highs, when the shares hit a valuation of just over 47 times forward earnings. That multiple now stands at 23, back at about 2019 levels. That does not reflect the inroads made into international markets and online expansion since then. For investors willing to play the long game, there are still solid returns to be mined. Building the business in the Asian market is one fount of revenue growth, particularly as the Chinese economy reopens after Covid. North America is the biggest contributor to revenue, which illustrates the rewards to be gleaned from geographical expansion. Online sales had grown to 22 per cent of the total last year.
In December the group agreed a licensing deal with Amazon to develop films and television shows based upon the Warhammer universe. Licensing the company’s intellectual property might be a less steady source of income than retail sales, but it is almost pure profit. The group is highly cash generative, with net cash building to £68.1 million at the end of November, from £41.4 million at the same point in 2021. That means dividends are also pulling more weight in the total return delivered to shareholders.
The house broker Peel Hunt expects this year’s dividend to total 295p a share, which would leave the shares offering a dividend yield of 3.4 per cent at the current price.
ADVICE Buy
WHY Expansion and licensing deals could boost the shares
