James Faulkner on WatsHot in the small cap market: Xaar and GECTECH

Shares in Xaar (XAR), “the world-leading independent supplier of industrial inkjet printerheads”, plunged earlier this week after the company lowered its guidance for sales and profits for 2014. Its sales to the ceramic tile market are now expected to decline in 2014 reflecting price reductions in response to competitive pressures, although volumes and market share are said to remain in line with expectations.

Interestingly, while the shares fell by around a third (and have more than halved during the year to date), broker N+1 Singer only put through a reduction of 13% to its earnings forecast for FY14, and 12% thereafter. Could a buying opportunity be opening up here?

Gone too Xaar?

To be frank, the rating of the shares prior to the crash was far to high for a company which constantly has to strive to stay one step ahead of the competition. Trading at Xaar has followed a regular pattern whereby the firm introduces a new technology and makes lots of profits, competitors eventually copy it, margins get eroded, a new technology is introduced ad infinitum…

A rating of c.25x was certainly looking toppy against this backdrop. But the shares have taken a beating and are currently trading on 11.8x consensus forecasts, falling to 11x for FY15 and 10.2x for FY16. For a market leader, this could be worthy of further consideration, especially given that Xaar is estimated to be sitting on a net cash pile of £55.9 million by the end of 2014.

2013 saw Xaar’s sales soar as it penetrated the Chinese ceramic printing market. However, although sales volumes to the ceramic tile market have stabilised at c.80k units per annum, average pricing is now expected to fall c.10% in 2014 due to price pressures from competitors. The impact on sales would have led to a whopping six percentage point drop in operating margins to c.24%, but this is likely to be offset by capitalisation of development costs for the firm’s Thin Film technology following its successful technical demonstration, hence operating margin guidance moves to c.28‐29%, which is still pretty impressive in light of the competition pressures.

New products…

So the key for Xaar is how it will go about reinjecting some growth into its performance in the face of these pressures. It’s therefore good to know that in fact Xaar has more new products in development than at any time in its history. The Xaar 1002, a next generation printhead launched in March, is performing well and is quickly being adopted by OEMs. The 1002 is said to offer a step-up in performance vs the Xaar 1001, thus helping to maintain the group’s competitive edge in its industrial and packaging markets.

Xaar 500 inkjet

In terms of the launch pipeline, the Xaar 501 for the graphics and packaging markets is currently undergoing OEM trials and is on schedule for commercial sales in Q3/Q4 2014. Project Thumper, a printhead which delivers significantly larger drop sizes for application of glaze to ceramic tiles and for other industrial coatings, is also in trials, with commercial revenues expected to begin in 2015. Looking further out, development of the next generation Thin Film P4 technology remains on schedule for commercial sales in 2016. Given that investment in R&D doubled to £16.4 million (12% of revenue) in 2013 with R&D headcount increasing by 64% year on year, Xaar looks well placed to continue to churn out new technology.

In a market that is continually being scrapped over by the OEMs and the generic competitors, Xaar certainly has its issues. However, the valuation no longer looks silly and the firm has the financial firepower to continue to support its culture of innovation and investment, which will hopefully deliver a steady stream of new products in the future.

GETECH

Another prior strong performer that has taken a battering of late is oil services firm and Leeds University spin-out Getech (GTC). An expert in the provision of exploration data for the petroleum industry, Getech’s principle activity is the licensing of its extensive gravity and magnetic data sets, interpretation reports and geophysical studies to major oil & gas and mining companies, aiding them in their exploration strategies.

Since the 1980s, the company has built up what it believes to be the most comprehensive set of datasets of any company operating in the sector. By utilising GETECH’s resources, oil & gas companies can delineate the spots with the highest potential for success without having to carry out major surveys of their own, thereby reducing cost and risk simultaneously. GETECH can customise its data to suite individual client needs. It can also use them to add value to its petroleum systems studies.

Getech suffers from a rather unpredictable revenue profile, which means earnings forecasts can be rather unreliable at times. However, the company has recently had some success in new business for its flagship Globe product, having announced a major new contract with a total value of $2 million earlier this month and contributing to a growing business pipeline.

The market cap is a measly £13.3 million and there is cash and financial assets of £4.1 million (and no debt) on the balance sheet. For such a small company Getech also pays a generous dividend, with last year’s 2p payment making for a 4.6% historic yield.

Consensus earnings forecast points to EPS of just over 6p for the current year to July, which would mean that the dividend payment is covered c.3x by earnings, which is all for the good given the vagaries of trading at Getech. Ex-cash, the shares are trading on a prospective P/E of around 5x, which looks good value given that Getech’s portfolio is continually sought after by the oil majors.