Investors’ Chronicle: Draper Esprit, CareTech, Volex

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BUY: Draper Esprit (GROW)

The venture capital group is poised to tap the market for another £111m, writes Alex Newman.

Full-year numbers for Draper Esprit arrived this week in a hail of updates from the listed venture capitalist. Top of the agenda was a plan to raise around £111m through the sale of new shares — the fifth time the group has tapped equity investors for at least £100m in secondary funding since its 2016 IPO.

The terms of the placing — an 8 per cent premium to net asset value and just 4.6 per cent below the shares’ undisturbed price — reflect much-improved market sentiment. This time round, retail shareholders were also given the opportunity to invest on level terms with the institutional investors and directors, thanks to a subsidiary offer via PrimaryBid.

The equity market access group was one of several later stage investments for Draper in the year to March. Alongside new stakes in used car online marketplace Cazoo and fraud detection specialist Ravelin, Draper also banked £206m of cash realisations after exiting or selling down positions in Peak Games, TransferWise and recent London market debutant, Trustpilot.

This helped boost the portfolio value by 58 per cent, highlighting not only strong investor demand and excellent market liquidity in technology companies, but also Draper’s ability to pick winners. Just three of the group’s 17 largest investments saw negative revaluations over the past year, and then only by a combined £3.6m, against a total fair value gain of £357.8m.

After a blistering period, growth expectations have been revised down to 15 per cent for the coming financial period. But a widening pipeline of follow-on investments justifies the premium to net asset value.

HOLD: CareTech (CTH)

The Aim-traded group’s net debt dropped slightly and it raised its interim dividend to 4.6p, writes Harriet Clarfelt.

Social care company CareTech cited “considerable resilience” in its half-year report as it posted underlying cash profit growth of almost a fifth to £49.4m on the back of strong revenue growth. A very small proportion of its users are deemed “high risk” by the NHS, helping it to keep all of its sites open during the coronavirus pandemic.

“Covid-19 has highlighted the importance of having community based, high quality social care facilities to relieve the pressures on the NHS,” said executive chair Farouq Sheikh.

The group supports about 5,000 children across more than 550 services across the UK.

The group’s top line improvement was buoyed by a combination of organic growth and the acquisition of a majority stake in Smartbox last October — something Sheikh depicted as a “significant milestone”.

Smartbox makes software and hardware that provides communication aids, environmental control devices, computer control technology and interactive learning for disabled people with speech difficulties. “Our belief is that digital adoption will play a significant role in enhancing the independence of our service users,” said Sheikh.

CareTech’s adults services business posted revenue growth of more than a quarter to £83m with cash profits up 12 per cent. The group attributed that “robust” performance to cost management and lower agency usage, though the profit margin dropped slightly from 25.5 per cent to 22.8 per cent.

Meanwhile, revenues rose roughly a tenth to £134m within the group’s children’s services division. Management pointed to longer stay placements here and fee increases helping to support margins.

Net debt dropped from £269m to £263m as at March 31, while adjusted net cash stood at £49.2m — up from £38.2m. Operating cash flow conversion at the period-end stood at 99.7 per cent. The group directed that cash towards buying 17 new developments, the purchase of Smartbox and the transfer of seven highly specialised adult service facilities from The Huntercombe Group in November.

Looking ahead, management is optimistic about expanding in the UK and in the Gulf region, where it also has offices and investments. Lending weight to that positive sentiment, it has raised its interim dividend to 4.6p a share (up from 4p).

Aim-traded shares in CareTech are up more than a half over the past 12 months. Based on brokerage Numis’s expectation of earning per share of 50.3p in full-year 2021 (up from 44.9p in 2020), CareTech’s forward price/earnings multiple sits at 12 times.

BUY: Volex (VLX)

The cable and power products group is capitalising on the shift to electric vehicles, writes Nilushi Karunaratne.

Volex raised its full-year guidance in April, pointing to “at least” $41m (£29m) of underlying operating profit. In the end, the cable and power products specialist actually generated $43m of profit in the year to April 4, with the 36 per cent increase being driven by higher sales to the electric vehicle (EV) and data centre industries.

The company makes power cords and plugs for EVs, and while this is currently Volex’s smallest business, sales from the electric vehicles division almost tripled to $53m in the period.

Meanwhile, with cloud computing and data storage becoming even more important during the pandemic, Volex saw customers stock up on high-speed data centre products to reduce the risk of supply chain disruption. This offset lower demand for devices related to industrial automation and building control systems, pushing revenue from the group’s “complex industrial technology” segment up 13 per cent to $114m.

The medical business was the only division where sales declined, with Covid-19 delaying the installation of larger therapeutic and diagnostic equipment in hospitals. So, despite higher demand for products related to respiratory care, the segment’s revenue dipped by 3 per cent to $113m.

Having cut costs and sold more higher-value products, Volex’s underlying operating profit margin expanded by 1.8 percentage points to 9.7 per cent. This margin progression came even in the face of increased shipping and raw material expenses.

While the group is able to pass higher copper prices on to its power cord customers, there is a slight delay.

Panmure Gordon believes that margins will stabilise around the current level, saying that Volex is “firmly established as a low-cost producer”. The company has invested in its manufacturing base to expand capacity and increase automation, doubling production space at its plant in Indonesia. This facility produces data centre cables for US customers and provides a way to sidestep US-China trade tensions.

Volex has swung from $32m of net cash (excluding lease liabilities) to $7m of net debt, reflecting $47m of cash spent on acquiring Turkish power cord manufacturer DE-KA in February. It has now made six bolt-on additions over the past three years, and DE-KA is its largest purchase to date, contributing $9m of revenue in full-year 2021.

The company is aiming for underlying operating profit to reach $65m by 2024, a 58 per cent increase on full-year 2021. Panmure Gordon currently has $58m of profit pencilled in for that year but says that Volex’ target should be achievable with further mergers and acquisitions. The broker is forecasting that profit will rise to $50m in 2022.

Volex should continue to benefit from long-term structural growth in the EV and data centre market, which currently account for just over a fifth of total sales. The group concedes that competition will likely increase in the EV charging space, but it is looking to remain one of the lowest cost producers. While the shares have risen fourfold from their “Corona crunch” trough to 367p, they are still trading at a reasonable 20 times consensus 2022 earnings.

Chris Dillow: The bubbles we deserve

Asset price bubbles are not what they used to be — which tells us something about the economy.

Historically, bubbles have been associated with optimism and even utopianism. In his classic The Great Crash, 1929, JK Galbraith described how the bubble of the 1920s was fuelled by “boundless hope and optimism”. Similarly, bubbles in internet stocks in the late 1990s or railway stocks in the 1840s were accompanied by the idea that new technologies would transform society and the economy and investors bought into them in part because they thought they were getting a piece of a better future.

High asset prices today, by contrast, are founded not upon optimism but pessimism. High valuations of US big tech companies owe a lot to the belief that their monopoly power is entrenched and persistent. That betokens a pessimism about the strength of competition and creative destruction, which are the forces that have traditionally fostered economic growth. And the now-faltering boom in cryptocurrencies is founded in part on expectations that people will lose faith in “fiat money” — something which is only likely (if it happens at all) in a horrible political and economic crisis.

Even high house prices are in part a sign of pessimism. For one thing, they’ve been driven up largely (if not entirely) by low interest rates, which are themselves a symptom of economic stagnation.

What we’ve seen, then, is an important but overlooked change. Whereas bubbles used to be associated with hope, they are now associated with pessimism.

This isn’t to say there are no technical breakthroughs now. There are. Our escape from the pandemic is due to developments in messenger RNA, and green energy offers much hope. One reason why investors should consider private equity funds is that they give us early exposure to companies using such technologies.

Equally, therefore, many technologies have not yet enriched equity investors. 3D printing, the internet of things, neural networks and graphene have been discussed for years, but few of us have seen the benefit in our portfolios.

Investors now know that what matters most for a company is not the size of its potential market but rather its market power — its ability to convert such growth into profits. Hence the high valuations of companies with monopoly power — be they as otherwise different as Microsoft, Diageo or Games Workshop. Investors have shed their illusions about capitalism: they now realise that what matters is the bottom line, not romantic stories about “the rapid improvement of all instruments of production.”

This recognition of the importance of monopoly, however, is the counterpart to stagnation. As New York University’s Thomas Philippon has documented, the decline of competition and rise of monopoly is one cause of the US’s slower long-term growth — hence the demise of bubbles based on optimism.

This is a particular instance of what Northwestern University’s Joel Mokyr has called Cardwell’s Law (named after the economic historian Donald Cardwell). “Every society, when left on its own, will be technologically creative for only short periods.” Eventually, he wrote, “the forces of conservatism” slow down creativity as they preserve their own power and privilege — in this case by entrenching monopoly power.

Chris Dillow is an economics commentator for Investors’ Chronicle

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