Volex - Powered For A Recovery?

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It has been a shockingly bad 7 months for holders of FTSE All-Share stock Volex (LSE:VLX) who have seen the value of their shareholdings eroded significantly following a series of disappointing news statements. The company is part of the electronic and electrical equipment sector of the LSE and constructs components for a variety of devices. The share price of the stock stood at 250p entering September 2012, but it has since fallen significantly to a current share price of 108p. The company has ~62.5m shares in issue capitalising it at a modest £67.5m.

The current price movement of Volex has been quite volatile with 110p+ seen in recent days having rebounded off a 95p level. The 100p will undoubtedly form good round number support considering this is where investors are likely to put limit buys at the moment. The movement over the next week will determine whether further horizontal movement is forthcoming or whether an upward trend can be created. In the latter case, it would be fair to set a 150p price target. The quick recovery from the last significant drop is also encouraging as it proves that buying pressure still exists in the market. This has been further confirmed by the lack of a sizable retrace. The share price currently stands at levels not seen since early 2010. Major shareholders for the company include NR Investments and GoldenPeaks Active Value. At the time of the last reported holdings figures the two firms held around 26.3m shares between them equivalent to 42% of the issued share capital. However, it is highly likely that these holdings will have changed over the last couple of months. Directors have also increased their holdings recently. The CFO, a NED, the Deputy Chairman and CEO Ray Walsh have all added shares to their portfolio with the total cash consideration amounting to approximately £160,000. While this is not a huge amount it shows that the management are at least partly confident in a recovery of the share price.

So who exactly are Volex? The company is an international supplier of optical, electrical and digital connections. In particular the company focuses on producing connectivity components and fibre optic cables. The company has previously supplied connections for Apple's range of iPhone and iPod products although this has since changed. As per the price chart there are two clear drops that have occurred in the latter half of 2012. The first of these drops took place in September when the company released a trading statement. The statement noted:

Courtesy of aditza121 on flickr
"In light of a recent unexpected change in forecast demand from the Company's largest customer in its Consumer sector and the continuing adverse macro-economic conditions, the Company now anticipates that revenue and profit for the year ending 31st March 2013 will fall short of Management's prior expectations. Whilst total Group revenues for the full year are anticipated to show year-on-year growth of approximately 5%, the lower than expected Consumer revenue and resulting loss of operational leverage will impact the reported operating profit, which Management now expects to be broadly in line with that of FY2012.
These lower growth expectations are driven primarily by a delay in product launches and a change in product component strategy by our largest customer. Furthermore, we are also experiencing lower current and forecast demand from a number of other Consumer sector customers reflecting the broader economic conditions. We expect revenues and margins in our Industrial, Telecoms/Datacoms and Healthcare sectors to be broadly in line with our previous expectations."
 
The statement was alluding to the fact that Apple had changed its connector for the new iPhone 5 which will significantly impact upon Volex's revenues considering it has been estimated that approximately 30% of their income comes through Apple. The company also blamed a delay in a number of product launches for the profits warning - arguably if this is the case then profit should pick back up once these are released. Due to the predicted fall in operating profit the company is implementing cost reduction schemes. Positively the company noted the following outlook:
 
"Despite the weaker than expected near term outlook, the Directors are encouraged by an increasing pipeline of prospective new customers and expectations of the Group's third consecutive year of increasing revenue, a trend that is expected to continue in FY2014."
 
The results of this were illustrated in the half yearly report released in late October. Revenues dipped to £164m, with operating profits falling to £3.5m, capex increasing to fund the efficiency programs and net debt of $4.6m - a figure not unreasonable for a company the size of Volex.
 
The second share price fall took place in mid-December and was caused by a further trading update released by the company. The company had expected H2 revenues to pick up, however the opposite happened with weakened market demand leading to another reduction in revenues to a full year range between £309m and £318m. Full year operating profit is also expected to be in the region of £7.2m-£9.2m. The drop took a substantial portion of the previous market capitalisation off the company and the current figure of just £67.5m thus looks undervalued on an earnings basis. The company did attempt to mitigate the second profits warning by announcing that reductions in operating expenses had already exceeded the pre-set 10% level, although this failed to reduce the share price collapse. The company also noted that it was 'accelerating' a move to higher margin product portfolio.

Evidently the company has been adversely affected recently by two main issues; becoming over reliant on one single company and being part of a sector that is not immune to the economic downturn. While the company can only change this to an extent, the company did announce in its 2013 Interim management statement that they had managed to win new business with a 'major global technology company'. Clearly this bodes well for FY2013 as it should offset some of the reduced revenue from the loss of Apple. However, the IMS also stated that net debt as of the New Year stood at $14.8m, a significant increase from the previous levels stated in late October. The company also noted that net cash from the last FY results stood at £2.4m which was slightly peculiar considering  for the last set of FY results revealed cash and cash equivalents of over £25m. The reluctance to release an updated figure would explain the increase in debt over the recent months. At the end of September 2012, these cash and cash equivalents had fallen to circa £12.14m which coupled with a likely increase in bank loans would explain the overall debt increase. The expected $10m annualised cost reductions will also partially offset this figure. This should not be too much of an issue at present though - the company has noted that "Despite reduced cash generated by operations and increased capital expenditures, the Group remains conservatively financed with ample headroom on both its banking facilities and covenants".

Courtesy of ben_osteen on flickr

The only other significant RNS that has been released since the start of 2013 is that Volex acquired AppliedMicro Active Optical Technology for a cash sum of approximately $2m. The acquisition was pursued in order for Volex to obtain an entry point into a higher-margin business that promises to have substantial future potential particularly in the telecommunications industry.

Volex is quite a difficult company to value particularly considering the recent volatility with respect to earnings and the missed expectations from the board of directors. However, with operating profit for calendar year 2012 expected at around £7 million, the market capitalisation of £67.5m does look to overvalue the company. Even factoring in the debt figure that stands around £10m, the current Price/Earnings multiple for the stock stands at just 5.4 - the sector-wide average for stocks stands around a multiple of 15 hence there is little doubt that the market is taking into account future downside catalysts.

Brokers have a variety of target prices for the stock although the vast majority of them including Investec, Canaccord and N+1 Singer have hold ratings on the stock probably pending the full-year results. The next trading update is scheduled to be released in the week commencing April 8 2013.

Taking into account the financial position and operating performance of the company upside potential exists. Potential new contracts combined with aggressive cost cutting should help to reduce the negative events that materialised in late 2012. market sentiment towards Volex is currently shot, but prior to the first warning the shares traded at a much higher level. In addition the directors have validated the lowly share price through commencing the purchase of stock - not many directors of companies are committing to this in the current economic climate so there is clearly a vote of confidence from the board itself. At 108p/share the company is without doubt, a very high risk option but the potential for a recovery here is strong in my opinion and a rise towards 150p would be a good starting point. As mentioned in the chart, if 116p is breached there is blue sky ahead. All eyes are on the next trading statement for now - confirmation of revenue and profits being in line with adjusted estimates in combination with further cost-cutting progress should see confidence return to the shares. An operational recovery is what will boost Volex and taking a bullish contrarian approach to the market could reap dividends.

UPDATE 26/04/13 - Volex moved to neutral this morning following the recent uninspiring trading statement and a breach of technical support yesterday

3 comments:

  1. Interesting but as you say, high risk

    Will research further

    CraigJ

    ReplyDelete
  2. April 8 will be a key date. If the company can show that revenues have not slipped further and that cost reductions are still bing made then it may well rise

    jk81

    ReplyDelete
  3. Excellent write up, thanks

    ReplyDelete