TIPS

Buy Carclo at 95.5p
A tip from Smallcapshares.co.uk - 28/12/07

THE BUSINESS
Carclo (CAR) is a supplier of technical plastics components which it manufactures and sells worldwide. The company operates through three divisions.

Firstly, the Technical Plastics division, which operates via a number of independently run companies, designs and manufactures plastic components for the automotive, optical, medical and teletronics industries. The business operates from four locations within the UK, five in the US and from recently built facilities in the lower cost regions of China and the Czech Republic. Examples of some of the hundreds of products that the division makes are pipettes, helmet visors, and lenses for LED’s. Around three-quarters of Carclo’s total revenues come from the division.

Secondly, the Precision Products division owns a range of companies that design and manufacture lighting and control systems for the automotive and aerospace industries. The business supplies products such as lamps, antennae and cables amongst many others and contributes the remaining quarter of revenues to the group.

Finally, and most exiting in terms of blue-sky potential, the Conductive Inkjet Technology (CIT) division provides a unique patented process that allows pure metals to be printed onto plastics. This technology was invented by Xennia Technology whilst undertaking an application development for mobile handsets on a contract funded by Carclo. It was recognised that the invention had applications well beyond mobile telephony and Carclo and Xennia formed a 50:50 joint venture to develop the invention. The CIT process has since been extended to printing on silicon and glass substrates, and to using laser technology to produce extremely fine lines which are invisible to the eye. CIT is now fully independent of Xennia and employs 11 people – primarily highly qualified chemists and engineers.

Since 1997 Carclo has focused on its high quality Technical Plastics operations, which have expanded through acquisitions in the UK and USA and the development of operations in low cost regions. More recently, the company’s main focus has been on growing its specialist medical moulding and optical component businesses as well as expanding its general moulding businesses in the Czech Republic and China.

Carclo has also prioritised the commercialisation of CIT and the development of other technologies and proprietary know how. In conjunction with this strategy, the company has sought to dispose of non-core businesses and has made several disposals over the past few years.

MANAGEMENT
Chairman, Christopher Ross, has been with Carclo since September 2003. He is a chartered engineer and is currently on the boards of a number of other companies. He is the chairman of aircraft designer Antonov and Sonas Investments, deputy chairman of Manganese Bronze and a non-executive director of Lander Holdings. In the past he was the chief executive of Molins, Ricardo and Wagon Automotive.

CEO, Ian Williamson has been on the board of Carclo for 12 years and was appointed to his current position not long after joining the company in June 1995. He is the former chief executive of the engineering division of BBA Group. Williamson recently bought 16,000 shares in the company taking his total holding to just under 0.5 million.

Finance director, Robert Brooksbank joined the company in April 2004. After qualifying as a chartered accountant with Ernst and Young he joined Enron Europe before becoming a director of his family firm, Brooksbank Industries in 1997.

Non-executive director, Michael Derbyshire, is a chemical engineer and chairman of several private equity backed businesses including Rascal Acoustics and Aerial Facilities. He is also a non-executive of Havelock Europa.

Bill Tame, the second non-executive director, has significant experience in the finance world. He is the current finance director of Babcock International and in the past worked for Courtaulds before moving to Scapa Group as group finance director.

CURRENT TRADING
Carclo recently released an impressive set of interim results covering the six month period to 30th September 2007. Although revenues from continuing operations only grew by 3% to £37.7 million, operating profits grew by 19% to £2.64 million and pretax profits surged ahead by 39% to £2.35 million. Fully diluted earnings from continuing operations rose by 39% to 3.8p. The interim dividend was increased by 50% to 0.6p per share, in line with the increase in the prior year.

At the end of the period net debt stood at £13.6 million. This is £5.2 million less than at September 30th 2006 but £0.8 million more than at the end of March 2007 due to greater working capital requirements.

The Technical Plastics division managed to grow its sales by a modest 3.1% to £28.7 million despite a negative impact from the US dollar exchange rate. Operating profits were hit by costs associated with moving some of its programmes to China and the Czech Republic and went down slightly, from £1.6 million to £1.5 million. Highlights over the period included the company’s largest customer in the medical diagnostics market choosing to buy all of its singleuse components solely from Carclo. In the second half of the year the European business should perform better as the programme transfers are completed. The company also anticipates further strong growth in the medical content in the US and China.

The best divisional performance during the period came from Precision Products which managed to grow operating profits by 88.1% to £1.7 million despite sluggish revenue growth of just 2% to £10.2 million. The profit growth was partly due to an increase in demand for higher margin Multiband antennas supplied by the automotive business. Profits were also boosted by growth in new business for LED lighting for supercars - cars at the higher end of the market such as Lamborghinis. Carclo won a number of major contracts in this market and expects rapid growth from the next financial year onwards in this area. In November the company launched its first automotive spotlight based on high power LEDs and further products are due for launch in 2008. In order to boost growth in the automotive lighting aftermarket, Carclo recently acquired Ultra; the leading UK distributor of largely LED based automotive lights.

Finally, progress at CIT has been steady and the division has now started to bring in revenues, although it is not expected to make a significant contribution to earnings in the current year. Carclo is currently looking at commercialising CIT across a number of areas.

OPPORTUNITIES & RISKS
There are three specific areas where Carclo believes that it enjoys substantial opportunities for growth. Firstly, in medical diagnostics, where it is a leading player in supplying components used for testing blood. The company estimates that it has around a 20% market share and going forward estimates that growth in the region of 10% to 15% per annum is not unachievable. Medical diagnostics should account for around 15-20% of sales in 2008.

Secondly, the company is also expected to grow in the areas of LED optics and lighting where high power LED’s are set to replace traditional lighting across many markets due to the fact that they are cheaper to run and last longer than traditional incandescent lighting. Carclo’s LED business is growing rapidly and the company is currently one of the leading suppliers of collimator optics, devices used to direct light, for LED lighting. Carclo estimates that it has around a 20% share of the collimator optics market, which is growing at around 15-20% a year. Going forward the company believes that it can take market share away from its competitors due to the product’s technical leading position.

Finally, the company believes that the CIT technology could be applied to a host of other products such as sensors, LED displays and solar cells. In particular the line technology has the potential to change the way that flat panel displays are designed and manufactured and as such could make significant revenues for the company. The company expects revenues from CIT to grow strongly into 2009 and beyond.

Moving to the risks and one of our major worries is the company’s balance sheet which includes a £11.2 million pension deficit as well as net debt of £13.6 million. However, we think that the debt is manageable. At the 2007 interim stage pre-tax profits covered interest payments by a comfortable six times and with cash inflow for the year estimated to be around £4 million these figures are expected to steadily fall over the coming years.

Since June Carclo has seen increasing upwards pressure on polymer prices – this will add significantly to raw material costs. It is the company’s policy to pass through the increase in material costs to its customers so there may be some demand issues if this persists going forward. The company also has a large reliance on a few major customers for its revenues. In the 2007 financial year its top 5 customers accounted for 41% of revenues. The loss of any of these would materially affect earnings. Although the company receives its revenues in several different currencies cashflow is managed so that inflows and outflows are matched as closely as possible. In the past there has been a small mismatch in doing this but nothing large enough to be worried about.

VALUATION
Shares in Carclo reached a seven year high of 132.5p at the beginning of August this year but we think that they have been oversold since. In the current year to 31st March 2008 the company should post revenues of £80 million, pre-tax profits of £5.7 million and earnings of 9.1p. The steady should continue in 2009 when revenues are forecast to hit £81.5 million, pre-tax profits £6.7 million and earnings 10p. Considering the growth prospects for the medical and LED areas these forecasts could well be conservative and any commercial successes in the CIT division, which have not been reflected in these estimates, could add significantly to earnings.

The shares trade on a current year multiple of 10.5 times earnings falling to 9.6 times in 2009, and that looks good value to us. Due to the recent sell off and the growth prospects of the company’s products we can see both short term and long term upside in Carclo. BUY.

EPIC: CAR
Market: FULL
Spread: 93p - 98p (5.1%)

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