James Faulkner’s Small Cap of the Week is Filtronic – Hold the line

Filtronic (FTC) is not a company with a great track record when it comes to meeting forecasts. After riding a wave of infrastructure spend on the back of investment in 4G and LTE in 2013, the conclusion of a significant project to deliver 4G (LTE) interference mitigation filters and a longer lead time for expected contracts from new design wins with OEMs saw the firm report a loss in FY14.

However, given that the firm is essentially at the cutting-edge of microwave electronic product development, the current market cap of just over £20 million looks potentially interesting, not least given the fact that there is net cash on the balance sheet, and that one broker is forecasting an adjusted pre-tax profit of £4.9 million for FY16.

The business…

Filtronic’s Wireless business develops and markets innovative customised filters, combiners, and microwave subsystems which enable operators to use their existing network infrastructure to overlay 3G and 4G (LTE) services, as well as providing OEM customers with next generation filter solutions for 4G (LTE) base station units. In this vein, it stands to gain from the expansion of mobile telecoms infrastructure that is being driven by the growth in data volume. This is a long-term trend that appears secular in nature, so represents a good foundation for growth, prima-facie at least.

Meanwhile, the Broadband business designs and manufactures customised microwave electronic sub assembly components that are integrated by OEM’s into radios for telecom network backhaul links and by a leading radar manufacturer into its aerospace products. This part of the business recently relocated its operations to a new facility at North East Technology Park (NETPark) in County Durham, a move which has enabled the business to reduce its fixed costs and achieve profitability on a monthly run rate basis.

Financials…

FY14 was a poor year for the company. Although the year saw the introduction of several new products and was involved in a number of custom projects which have led to design wins with both original equipment manufacturers (OEMs) and network operators, sales revenue reduced to £32.9 million from £40 million for the reasons mentioned above, with an operating loss before exceptional items and the amortisation of intangibles of £0.4 million (2013: profit £3.1 million). Notably however, the Wireless division remained profitable throughout despite accounting for all the fall in revenues. The firm also remained cash generative at the group level, to the tune of +£2 million, which largely resulted from the unwinding of working capital associated with projects completed in the year and a reduction in inventory in Broadband.

What’s it worth?

With the firm reliant on large scale OEM contracts which can be unpredictable and lumpy, this is not a business that should command a high rating. However, with net cash of £2.5 million and an (undrawn) invoice discounting facility with Barclays of £2 million, neither is this a company that appears to be in trouble. In fact, the outlook appears to be positive, with the company having achieved “a significant number of design wins at key OEMs”, which it expects to enter production through FY15.

Furthermore, this is an innovative company with an R&D spend of £6.4 million in FY14, all of which was expensed through P&L (although the group’s policy is to capitalise development expenditure as intangible assets when all the qualifying criteria have been met). With this in mind, I was interested to read broker Panmure Gordon’s prognosis for the coming years…

“We have left our FY 2015 forecasts essentially unchanged – revenue of £32.7m, adjusted operating profit of £1.1m and adjusted pre-tax profit of £0.3m. We have also introduced a new set of forecasts for FY 2016 which, conservatively, reflects management’s view that the scale of existing customer activity (c40 live projects, 80% with OEMs, a number of design wins already secured) supports a significant increase in revenue and profitability in FY 2016. On this basis, we are forecasting FY 2016 revenue of £50.4m, adjusted operating profit of £4.7m and adjusted pre-tax profit of £4.9m.”

Obviously these forecasts are dependent on the timing and deliverability of contracts, but the broker notes that it “will be keeping a close eye on revenue development, particularly as we move into the second half of FY 2015”.

Should there be any evidence of building momentum at this time, the situation could get a lot more interesting on the back of Panmure’s FY16 forecast, which would translate to a FY16 P/E of just 5.2 times.

As I said, I like the backdrop of growing data volume forcing network infrastructure investment, which in turn should send more work Filtronic’s way. A potential “special situation” further down the line.