Zytronic - Touching 300p

http://www.zytronicplc.com/


The 21st Century thus far can be characterised by a range of important technological developments; one of those developments has been the proliferation of touchscreen interfaces that have allowed for the creation of touchscreen mobiles, tablets, but also larger machines such as touchscreen vending machines. With a continued move towards touchscreen capability and away from physical keys or buttons, Zytronic appears well placed to continue building its sales pipeline through 2015 and into 2016. Although the share price is up over a third over the past year, there still appears to be useful upside from a company with an excellent balance sheet and cash flow profile.

Technicals

Zytronic Logo

The technical outlook for Zytronic is bullish conditional on a convincing break above 300p and a period of consolidation that does not see a retracement below that figure. As can be seen over the 15-year period, the share price has tested 300p on three occasions previously - in 2001, 2005 and 2012 - yet on each occasion the key level has not been held, with fundamental drivers meaning the share price has retraced. However, each low has been higher than the last, creating an ascending triangle. If 300p is breached and held, then medium-term upside towards 400p looks likely, given the sheer scale of the pattern and lengthy period of time that 300p has held as resistance for.

The pace of the reversal off the closing low around 150p is testament to the temporary nature of the issue that impacted Zytronic over that period. It is important to note that the market may be wary of putting Zytronic on a premium rating in the near-term as a consequence of the customer dependency risk that struck in 2012/13, but that caution may and should subside with positive operational progress.

There are few other notable points to draw on at this point, with no recent director purchases or sales, although several institutions - including AXA and Cavendish Opportunities - do hold notifiable stakes in the company. The spread is currently reported as spanning 295p and 300p although it is possible to purchase or sell within that spread with an ask price of 299p. Liquidity is generally good, although the spread can widen periodically.

Operations


Zytronic is a leading global manufacturer of touch-based products, with a particular emphasis on larger screens typically used for gaming, public access and industrial applications. To achieve this, the company has patented Projected Capacitive Technology (PCT) and Mutual Projected Capacitive Technology (MPCT) under its belt that enables it to protect its gross margins and have a defensible position within the market.

The company is based out of Newcastle where it owns a cleaning room and progresses projects from design through manufacture, with its operational facilities globally largely catered for through a network of channel partners who source and initially develop leads.

This global scale has enabled Zytronic to produce for a range of uses including self-service kiosk interfaces for MRI (a customer in the US operating in the Food & Drink industry), induction cooktops for Bosch and Siemens, vending machines in Japan and sports tables in Australia. Of course, this is only a small selection of the number of projects undertaken, but it underscores the range of applications that Zytronic's touchscreens cater for.

And it is the mechanics of the technology that enable Zytronic to cater for those markets; compared to the majority of competing technologies, the active component of Zytronic's touchscreens are actually embedded behind the screen, ensuring that the screen is fully rugged and able to withstand greater shocks compared to most. Within touchscreens there are several main competing technologies to the projected capacitive technology; surface capacitive, infra-red and acoustic, although projected capacitive largely trumps these with just a couple of general advantages including improved dust/water resistance and better dual-touch capability against some of those comparators.

Of course, that's not to say that there is little competition, and Zytronic has been quick to note that "in-cell touch" - which allows small displays to have thinner form factors with a single-layer display - is disruptive, but is largely constrained to devices of mobile or tablet size. Nevertheless, Zytronic has and will continue to innovate through expenditure on research & development and this has already yielded interesting new variants including particularly large screens and curved screens. For example, Zytronic can now manufacture screens up to 85 inches (which is useful for systems such as touch-tables) with MPCT allowing "up to 40 independent touch points with millisecond response times."

In fact, whilst the smaller end of the touchscreen market is highly competitive with high-barriers to entry (as a result of bulk-purchasing from recognisable brands), Zytronic has carved out a niche in medium-sized to larger screens, with the bulk of its revenues derived from screens in excess of 15 inches. Applications for the touchscreens can be split into a range of different categories:
  -  Gaming (e.g. casino systems)
  -  Industrial (e.g. kiosks; these tend to require gloved hand functionality)
  -  Financial (e.g. ATMs; these tend to require all weather usage, vandal resistance and encryption)
  -  Vending Machines
  -  Signage (e.g. interactive tables)
  -  Other (includes Telematics [control systems], cooking surfaces and healthcare)
Consequently, in some respects Zytronic is a play on the continued likely expansion of touchscreens into new areas such as touchscreen keyboards.

In terms of the actual split between screen sizes, Zytronic saw growth in all but the smallest screens in 2014. Of particular interest is the rapid growth in the larger screen sizes, albeit from a low base. That is encouraging given the increased pricing flexibility at the larger sizes, hence superior gross margins and reflects an uptick in demand primarily from the gaming sector, which in itself is a potentially interesting niche for Zytronic to tackle.

The highest demand on a number of unit basis is clearly derived from screens between 15 and 19.9 inches, with this demand driven for largely financial, vending and industrial uses; of the main target markets, only telematics saw a decline in FY14, and telematics is relatively peripheral compared to other markets.

However, whilst the last full-year paints a rosy picture, it has been far from plain sailing with a profits warning at the back end of 2012 and entering 2013 leaving the share price down to as low as 150p. That was on the back of two broad issues. The first is one which many companies of insufficient scale have, which is high levels of customer dependency. In particular, the absence of one-off electronic display orders from ATM manufacturers left a hole in the order book versus the prior year, and combined with a delayed roll-out of a material Coca-Cola project in the US, the forward forecasts were left looking distinctly unachievable. Secondly, the company was in the process of discontinuing a legacy product line with the introduction of MPCT, and that was not handled particularly smoothly. Demand for non-touch screens does continue to decline at a rapid pace, but those problems are worth bearing in mind looking forward, as there is always scope for a re-appearance.

As can be seen from the chart earlier, that was a temporary 'blip' with a resumption of a strong share price performance since; the share price already 100% off the lows. To further progress the sales drive, Zytronic established a sales office in Atlanta, Georgia in 2014 and plans to expand its geographic coverage through further representation across South America & the Middle East, and planned expansion into Greater China with patent applications in place for new territories. Another development alongside the curved screens is to integrate encrypted touch solutions following work with Cryptera A/S; Cryptera have PCI certified encrypted payment solutions. There is plenty of potential for innovative new solutions to be integrated into the touchscreens, and both positively and importantly it is being achieved with modest CAPEX outlays.

In the latest set of results, a bullish tone was struck with Chairman, Tudor Davies saying:
"Whilst we are only a couple of months into the new financial year the sales and order book are ahead of last year and our focus is on continuing to increase value for shareholders now and into the future."

Financials

Whilst the underlying markets that Zytronic serves are interesting from a growth perspective, it's actually the sound state of the company's financials that is really attractive, and this keeps in line with my search for attractive free cash flow, which is again a rare attribute for companies below £50m to have.

However, starting from the top, these are the key figures released in the 2014 preliminary results:
   -  Revenues up 9% to £18.9m
   -  Gross profit up 41% to £4.9m
   -  Gross margins up from 28% in FY13 to 37% in FY14
   -  Pre-tax profits up 68% to £3.3m
   -  Adjusted diluted EPS of 19.5p vs.13.8p
   -  Dividend of 10p vs. 9.1p, representing a 10% rise
   -  94% of revenues are derived from exports. With the exception of the UK (£1.2m, down 20%), all regions saw growth. EMEA (£9.2m, up 10%), Americas (£4.3m, up 26%), APAC (£4.1m, up 2.5%)

The first point to note is that the profit growth figures are relatively useless. Why? It's because of the reason outlined earlier where 2012/13 was a bad year characterised by customer dependency issues hitting the business.

From that we can look at the true performance of the business; the most significant point from those outlined are the excellent gross margins at 37%, which reflect not only on the quality of the product, but the efficient cost base that Zytronic has managed to maintain. Equally important is the split of revenues between the declining non-touch screens and those that are touch. Non-touch screens continued to decline apace by £0.7m to £4m with ATM display filters representing the majority of those revenues. On the other hand touch revenues increase 18% to £14.9m, representing 79% of the group's total, hence the revenue split is attractive.

Zytronic also has a strong record of paying a useful and increasing dividend. Despite the profits blip in 2013, the strong balance sheet enabled a progressive dividend policy to continue with the dividend now having doubled from 5p to 10p since 2009. That provides a useful ~3.33% yield, which helps protect against downside going forward. The balance sheet nothing short of excellent. Total assets are 5x current liabilities with inventories and receivables alone, greater than current liabilities; current assets are 2.9x total liabilities. 94% of total assets are tangible and the current assets contain £7.8m in net cash (or £6.3m minus a property-backed mortgage).

That net cash figure is a result of the superb cash generation aforementioned. For FY14, pre-working capital cash generation stood at £4.57m and post CAPEX on research & development, free cash flow stood at £3.98m giving an excellent free cash flow yield of circa 10.55% when stripping back the substantial net cash pile. Even disregarding tax overprovisions and applying a higher tax charge, the free cash flow yield is circa 9.95%.

Consensus 2015 forecasts vary between brokers Arden and Numis, albeit with consensus 2015 EPS estimates for 20.88p, rising to 23.76p in 2016. Dividends of 11p and 12.05p are the consensus for both years, but with the cash flow profile, those look conservative given the Zytronic's trend of increasing the dividend by double digits in the past few years and the fact that the dividend will approach 2x cover. At 300p that puts Zytronic on 14.4x FY15 consensus and 12.6x FY16 consensus or11.9 and 10.5 ex-cash, which appear strikingly modest especially against the wider Electronic & Electrical Equipment sector average PE of just over 20.5, and around 18 for 2015. The sector boasts an average 2.25% dividend yield and circa 2.1x dividend cover.

A PE ratio of 18 corresponds to 376p for FY2015, but that fails to appreciate the significant cash pile and strong balance sheet; consequently that price would rise to 425p ex-cash. In terms of specific and useful comparator competitors, there are few. However, US listed Planar Systems - who develop video walls, non-touch displays and touch displays - trade on a 2015 PER of 20 and a forward EV/EBITDA of 14.6x.

Moreover, those consensus earnings estimates appear particularly undemanding on a pre-exceptional basis. As per the table on the right, Zytronic have released that active projects at September 30th totalled 69 against 41 in the prior year. Of the 69 projects, 29 are for signage, 11 for industrial, 10 for finance, with the balance derived from gaming, vending and other markets.

The only detractor from reported figures perhaps not exceeding forecasts is that Zytronic intend to incur an initial £0.4m in CAPEX to revamp and expand their clean room in Newcastle. In reality that is expansion for future growth hence stripping out those CAPEX costs may be a useful technique when looking at 2015 figures.

"The overall channel partner network has experienced little change since last reported upon in the 2013 review, except for the appointment of Priconics, a North American representative for the Midwest states, and the termination of Nishicom, our previous under-performing representative in Brazil. As we look to expand the coverage of our Mexican channel partner Phoenix in 2015, we anticipate that it will initiate coverage for Brazil as well as several other South American countries. "

Still an attractive investment proposition

Although Zytronic does still operate in an industry where there can be limited forward visibility, and the company's scale is still insufficient to comfortably protect against order delays or timing issues, the company under CEO Mark Cambridge has performed well and bounced back following the 2012/13 drop with a new series of product developments that should drive growth ahead. Forecasts for 2015 remain undemanding and particularly on the dividend level, there is scope for a beat or revisions through the year. On a pre-exceptionals earnings level, the number of active projects also provides encouragement that the existing forward estimates are conservative. Regardless, boasting a strong ex-cash free cash flow yield, a robust balance sheet, an attractive suite of products, and a potentially significant technical setup, the risk/reward is attractive with an initial 375p target representing an ex-cash PER of circa 15.5 based on conservative 2015 forecasts. Consequently I have put a Buy tag on Zytronic at 299.00p.

14 comments:

  1. Excellent review.
    Zytronic seem to be looking at new products. They partnered up with HUMElab to put touchscreens in house tables and the like in December and are going back to medical with this http://www.pddnet.com/product-releases/2015/01/zytronic-unveils-touch-sensor-tech-patient-care

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  2. Thanks el1te :0). This is an interesting one because I was so close to buying them last year on the drop to 200p but presumed wrongly that it was a sign of a profit warning :0(! 6 months on and its up 50% so I am bitter :0|! I've bitten the cherry today :0)

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  3. A company throwing off bottles of cash is a rare sight on AIM! Good find

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  4. Thanks El1te. I have had a tipple. Seems ZYT were also tipped by Shares Magazine 23.1.15. They conclude:

    "Strip out net cash from calculations and assume a 15-times price to earnings (PE) multiple by year end in September, and you’re looking at a share price of close to 420p, or 40% up from here. Given that the stock has previously hit highs of 362p, we believe this target is reasonable and achievable."

    As always only time will tell.

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  5. Hi El1te -
    I bought these early december last after the prelim results. Yours is a far superior analysis and I am thoroughly agree with your conclusions. Super share.
    Regards, Ram

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  6. closed above 300p! is this a sign?

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    1. Need a sustained breakthrough (i.e. no retrace below 300p over the next three days and ideally a break away towards 310p), but otherwise it would be a highly positive sign. Obviously not of interest for me to track now, but all the best! I'm pretty confident that the 375p initial target was fair.

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    2. thanks for your comment. Wasn't sure if you were still keeping an eye on old posts. Agreed the price needs to stabilise above 300p but given the narrow trading range for the last few weeks I am expecting it to stabilise in new territory. Always allowing for general market conditions. As always only time will tell.

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    3. Looks like we have established a beach head. Can we break out from here? Where are Easy Company when you need them!

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  7. well we seem to have built up a reasonable squad of armoured vehicles and front line troops ready for the assault on higher ground. 'Resistance is futile' as my electronics tutor used to tell me.

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    1. I do receive an email notification each time a comment is posted, but if you want to keep in touch via email to discuss anything then please do. Thanks for posting comments on the new articles.

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  8. Touching 250... Does anyone have any idea when to expect the reverse of the recent trend? The share looked strong to me at 300, but then this slightly worrying 20% setback. thanks/ Alex

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    1. Hi Alex,

      Although I obviously am not covering companies at present, I can give a quick run-down of the technical situation. I stated in this article that 300p was an important barrier, and although I believed it would be breached, it was a false breakout (see tutorial) and it has reversed back under. That reversal came from a fairly boring (but not bad) trading update.

      Given that Zytronic is a low-liquidity share, when a news update comes around and is uninspiring, it prompts some shareholders to sell their shares. In particular, those who have been waiting for a sell point and who were just waiting for the news update to see whether it was worth holding on.

      Consequently it reversed under 300p and has been technically weak since. Sometimes you have capitulation points where the share price falls quickly and for ZYT its now near 250p as you say, with an RSI well below the oversold 20 level. I think that it's fair to expect strong psychological support at 250p and if that fails there is a trendline base at ~235p (and trending upwards).

      In my opinion, I'd be pretty comfortable with saying that most of the damage has been done. The fundamentals are strong enough to cement 250p in my opinion. I would actually be doubling up the site position (if the site portfolio was still running).

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    2. Hi El1te,

      Thanks a lot for your comment! It was really useful for my learning process to understand the current situation. Still a lot to take on board from your tutorials. Regards, Alex

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