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While MS International (LSE:MSI) has a low share price relative to its average earnings over the last 12 months, i.e. a CAPE of 10.8 (see yesterday’s Newsletter), we have to acknowledge that profits have been on a downward trend for five years now. This leads us to search for compelling reasons to think that earnings might mean-revert over the next few years. This Newsletter starts that process by examining the performances and strategic positioning of it four business divisions.
Top line stagnation
Turnover for the entire business was around £45m in 2006. It was pretty much the same nine years later in 2015. For the years in-between it was generally in the range £51m – £56m. The latest year to April 2017 showed the company getting back toward the top end of that range at £54m. It’s clear that the company is not going forward fast in terms of turnover or profit.
However there are grounds for believing that a bounce-back to former highs is possible as the experienced directors overcome recent difficulties. Of course, I could be wrong, and they may no longer have the drive and talent they once had, and therefore will never bounce-back, but I detect a quiet optimism and capability.
Three of its divisions showed revenue growth in the latest 12 months. This would have been true of the fourth, the Defence division, were it not “for the rescheduling of a delivery, for a long standing international defence customer, into our 2017/18 financial year.”
Increased investment has impacted the 2017 profit results as the directors demonstrate their commitment to “optimise future potential”; they are not concerned with meeting City-folk short term expectations but instead make “considerable and wide ranging” investment across the divisions – over £1.5m spent (and written off) on R&D in 2017 (2016: £1.2m) and £4.4m on capital items in 2017 (£2.2m in 2016). They added £2.7m of freehold property in 2017 and £1m of plant and equipment.
Defence division
The Defence division has a Norwich base where it designs, manufactures and services a range of items, but the main output is “gunnery weapon systems”, ships cannons to you and me.
It seems that the quality of their gun-systems is well-known and the navies of at least 16 countries have bought them. For example, in November a French-built ship built for Senegal was launched with 30mm remotely operated cannon supplied by MSI.
There are already 250 MSI gun systems in place in the world. It also services those guns. Return on capital employed in this division is respectable, averaging 19% over 7 years:
| £m |
Revenue |
Operating profit |
Capex |
Assets minus liabilities |
| 2011 |
32.6 |
5.4 |
0.0 |
16.6 |
| 2012 |
29.9 |
6.6 | 0.1 |
15.8 |
| 2013 |
28.0 |
2.9 | 0.1 |
16.7 |
| 2014 |
19.4 |
0.9 |
0.1 |
14.4 |
| 2015 |
17.0 |
-0.2 | 0.1 |
14.1 |
| 2016 |
21.9 |
2.0 | 0.2 |
14.2 |
| 2017 |
20.8 |
1.8 |
0.2 |
12.2 |
| Average |
2.8 |
14.9 |
||
| Average operating profit divided by net assets |
2.8/14.9 = 19% |
The high average return on capital employed numbers give the impression that they can gain good margins in years of normal revenues (when fixed costs are not oppressive to margins).
In 2017 this division’s markets “remained testing, reflecting the many constraints placed on global defence ministries……Despite such unpredictability, it is important that we continue to invest in extensive new product development…as well as…marketing”.
This sector is notorious for swinging between feast and famine as defence procurement budgets rise and fall. One day we’ll have a feast – in the meantime operating profits of around £2m are fine to be going on with. We also have that sale of equipment held over from 2017 to boost things in the current year.
This division is worryingly dependent on major customers in any one year. In 2015 one customer accounted for £10.7m of revenue, similarly in 2016 one customer………………………………….To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
