James Faulkner on why Stadium Group Deserves a Wider Audience

Back on the value trail, Stadium Group (SDM) is in the middle of an interesting transformation from being a commoditised electronic components business to a technology-led group focused on its own IP and selling into several niche growth markets.

I like situations such as this, where a company makes a move up the value chain, as it can take some time before the market fully twigs on to the story, especially with small caps.

The shares have already begun to move higher, but with the order book having risen by 50% at the half-year stage, there appears to be more to play for.

Central to the firm’s transformation is the recent acquisition of United Wireless Ltd, renamed Stadium United Wireless (SUW). SUW specialises in the design and manufacture of machine-to-machine (M2M) wireless solutions that support wireless connectivity between devices across wireless technology, primarily cellular networks.

The business acts as a specialised M2M wireless integrator for original equipment manufacturers (OEMs) requiring a complete end-to-end connectivity solution for their equipment or devices. SUW has a strong customer presence in the automotive and telematics sectors, and also works with OEMs in the areas of ‘infotainment’ and vending, industrial equipment and asset tracking.

The M2M market represents a significant opportunity for Stadium

Cellular M2M connectivity services revenues, according to a study by ABI Research released in July 2014, are forecast to grow at 28% CAGR (compound annual growth rate) 2014-19 globally reaching annual revenues of $18.9 billion in 2019. Asia-Pacific is expected to be the leading region in revenue growth with 34% CAGR 2014-19 reaching revenues of $5.9 billion in 2019. Europe is expected to grow at 25%, North America at 28% and LATAM (Latin America) at 20% CAGR for the same period.

M2M-focused businesses attract high valuation multiples, with the UK’s Telit Communications (TCM), which trades on a current rating of c.20x, a case in point.

Source: Stadium Plc

That said, Stadium still draws c.57% of its sales from the legacy Electronic Manufacturing Services division (EMS), but with Technology Products having posted sales growth of 24% in H1 2014 (versus a decline of 5.5% in EMS), its share of revenue should decline quite rapidly going forward.

Over time, this should see operating margins rise as the better pricing power of Technology Products becomes evident in the group sales mix. It should also see the overall growth trajectory of the group improve. Meanwhile, EMS itself has been restructured to focus on a more narrowly defined set of markets in order to drive efficiencies. This included the closure of the Group’s Rugby facility and the transfer of production to Hartlepool and China. Cost savings of c.£1 million per annum were achieved from Q4 FY13, equivalent to an improvement of c.3% at the EMS operating margin.

So what are the negatives?

Although Stadium’s balance sheet looks clean, with a small net cash position at the interim stage (i.e. prior to the United Wireless acquisition), there was a pension deficit of £6.8 million at the end of 2013. During 2012, management agreed with the trustees of the scheme to make cash contributions of c.£0.8 million going forward. This looks manageable on current forecasts, as the firm should still generate positive free cash flows in future years. This should enable a progressive dividend policy alongside management of the pension deficit. Furthermore, there is the potential for cash contributions to reduce further in the medium term as discount rates become more favourable and as the deficit is paid down. It is also worth bearing in mind that the EMS division is operationally geared, so a significant downturn could push EMS into the red.

What’s it worth?

House broker Charles Stanley’s forecasts look well underpinned, with EMS expected to see a number of new business opportunities materialise in 2015, and the Technology division expected to go from strength to strength. The broker expects to see a normalised pre-tax profit of £2.7 million on revenues of £46.9 million, generating normalised EPS of just under 7p. In 2015, earnings should rise to 11.5p, putting the shares on a prospective multiple of just 8.3x. That kind of valuation appears to leave plenty of room for upside as the firm’s transformation takes hold.