One unwelcome phenomenon of the credit crunch has been the rapid and aggressive destocking by distributors and retailers, who have been forced to raise cash by slashing working capital levels. In fact, so severe has the contraction been that in many instances orders at upstream suppliers have simply fallen off a cliff in the past two months. I suspect this blip is an over-reaction, and should correct itself when we see an improvement in confidence and earnings visibility.
Victrex (LSE:VCT)
Take Victrex as a case in point. This Lancashire-based chemicals firm is a global supplier of high-performance thermoplastics. Its flagship Peek polymer is used as a substitute material across a wide range of industries including aerospace, automotive, electronics, food processing and defence. Peek’s advantages are that it is lighter, more heat resistant and stronger than many metals, and can be readily moulded into precision parts for car engines, aeroplanes, circuit boards, surgical implants and mobile phones. However, last Monday the firm announced that “demand had tumbled as our customers ran down inventories”, thus leading to a painful 30% dive in the shares. October volumes had remained strong at 218 tons, but “after a healthy start to November, sales fell to 118 tons following a marked slowdown”. Yet, despite the poor immediate outlook, the investment case appears intact, with the board adding that the “development pipeline of potential new applications remains strong”.
House broker Cazenove is forecasting 2009 sales and underlying earnings per share of £107m and 36.2p respectively, rising to £129m and 50.0p in 2010 – putting the shares on miserly p/e multiples of 11.3 and 8.2. The balance sheet is also secure, with net cash of £23.5m as at 30th September, excluding the small £5m pension deficit. Fine, but what are the potential catches? Well, firstly Peek is not patent-protected, providing a possible opening for rivals such as Germany’s Degussa and Belgium’s Solvay. Furthermore, Victrex’s dependence on the technology creates a risk if superior products are developed, and its production is located at a single factory, which also increases the danger if an accident were to occur.
Finally, the group exports over 90% of its revenues overseas, and is therefore exposed to foreign-exchange fluctuations primarily relating to the dollar, euro and yen –- although with sterling weakening of late, this should give a boost to earnings next year.
Preliminary results are due out on Tuesday 16 December.
Recommendation: speculative BUY at 410.5p (market cap: £340m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.