The industrial distributor RS Group is the ideal barometer for the health of global manufacturers. It has dropped faster than even a cautious market expected.
Underlying revenue growth slowed to just 1 per cent over the fourth quarter, behind market expectations and another deceleration from the 8 per cent annual increase recorded three months earlier. That has taken the shine off cost savings, which meant adjusted operating profits are expected to be a touch better than the £382 million forecast by analysts.
The distribution group, formerly known as Electrocomponents, has faced multiple challenges in pushing sales forward. True, the FTSE 100 group is operating against tough annual comps, when supply chain disruption and a strong bounceback in demand after the pandemic led companies to stock up. Now, demand is not only slowing as economic growth weakens, but manufacturers are also working through their supplies and some smaller customers have been lost altogether. The impact of the latter is nearly over, reckons David Egan, finance chief, but there may be more pain to take on customers running down stock.
Electronics accounts for about a quarter of revenue and more in the Asia-Pacific region, which accounts for a 15 per cent decline in sales there in the fourth quarter. The business, which caters to design engineers, is geared towards capital expenditure budgets, so more vulnerable to a fall in consumer demand. There were more idiosyncratic problems. A lag in its rebranded Allied Electronics catching on among customers in the US has also weighed on revenue. In the Americas, underlying revenue also reversed 4 per cent. Supplying components “just in time” means RS can charge a premium for the speed and breadth of products delivered. That has boosted pricing power, but it also makes the group acutely short-sighted over future revenue.
Of the revenue growth squeezed out during the fourth quarter, price inflation did all the heavy lifting, coming in at a high single-digit rate. As analysts at Numis point out, that implies a decline in sales volume of about the same magnitude. Why does that matter? Because during this new financial year RS will bump up against last year’s price increases. As the benefit from higher prices peters out, some of the cost inflation for products supplied by RS could remain. Last year higher sales prices provided a one percentage point benefit to the gross margin, some of which is expected to unwind. An easing in price inflation also exposes RS to weaker sales volumes.
Analysts have forecast adjusted operating profits that are flat on last year, at £390 million. Weaker earnings prospects are reflected in a depleted valuation. The shares trade at just under 15 times forward earnings, a comedown not only from a peak multiple of 30 in 2021 but also a discount to a long-running average of 19. The decision has been to slow the pace at which inventory is being built. At the end of September inventories stood at £632 million, 34 per cent higher than the same point in 2021, even if some of that increase will reflect product cost inflation.
The business throws off a lot of cash, which means the balance sheet is in strong form. Analysts think net debt ended March at £168 million, or less than 0.4 times adjusted profits. 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 rivals. Analysts at Jefferies reckon there is scope for £500 million to £1 billion to be spent on deals over the next two years. The question is whether Simon Pryce, who has been chief executive for four days, decides to pull back from some less profitable markets or product areas, or more ruthlessly reassess expansion plans.
ADVICE Hold
WHY The shares deserve their cheaper valuation in the face of weaker demand
Baillie Gifford
Scottish American Investment Company (Saints) is a rarity within the house of Baillie Gifford right now. The trust is still punching above its benchmark and has hung onto its pandemic gains; the FTSE 250 constituent’s shares are still a whisker above the price 12 months ago. Compare that with the crushing losses sustained by larger funds Scottish Mortgage or Monks.
Eschewing the raciest, loss-making names, as well as higher-risk giants such as Tesla, has provided a boost, and so has the presence of more defensive stocks such as Novo Nordisk, the Danish pharmaceutical group, which is the largest holding at 4.1 per cent of assets. Over the 12 months to the end of February, the value of the trust’s assets rose 8.9 per cent, against 2.3 per cent from the yardstick it attempts to beat.
Saints is a different sort of income investor, searching beyond the typical high-yielding stocks in the hope of delivering above-inflation dividends from companies it thinks capable of generating high capital growth as well. That means the portfolio includes names such as Microsoft and Apple, as well as more traditional income stocks — for example, mining giant Rio Tinto and insurer Admiral.
The bulk of the holdings fit into two portfolios: those the trust thinks can generate compound earnings growth of about 7 to 10 per cent a year — Procter & Gamble and PepsiCo — and those that could deliver a more rapid increase of 10 to 15 per cent, such as Chinese sportswear group Anta Sports.
Unlike Scottish Mortgage, Saints has no exposure to private companies, although about 6.8 per cent of assets are invested in directly held property and another 4.3 per cent in bonds.
Saints can lay a fair claim to backing all-weather stocks — it hasn’t cut its cash return to shareholders in more than 80 years. Even amid the turbulence of 2020, nine out of the top ten holdings increased their dividend payments.
The trade-off is that investors will need to stomach a lower dividend yield, which amounted to 2.7 per cent based on last year’s 13.82p-a-share payment, although that was a 9 per cent increase on 2021.
ADVICE Buy
WHY The shares have the potential to deliver a solid compound return
