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Questor: this foam-maker is hardly a household name – but many of its customers are. Buy
Questor share tip: Zotefoams’ lightweight foam sheets are bought by the likes of BMW, Nasa and Nike, and sales are growing strongly
Some stocks always look expensive and – to the frustration of those who want to buy them cheaply – seem to stay that way.
Croda and Halma are two examples that spring to mind, and both have a deserved reputation for making terrific long-term total returns. It may be too early to put Croydon’s Zotefoams in such exalted company, even if its history as a publicly quoted firm stretches back to 1995.
Zotefoams makes extremely lightweight foam sheet materials used in a range of applications including aviation, transporting goods, padding for shoes and cover for prosthetic limbs. Its ambition is to be the world leader in cellular materials technology in its chosen markets.
Even though the chemicals specialist cannot be described as a household name, many of its customers can. They include Toyota, Boeing, BMW, Nasa and sports shoe makers Puma and Nike, the latter a strategic partner since an exclusive development agreement announced in December 2017.
Zotefoams’ products are in hot demand and sales are soaring. As a result, the company is running hard to add more capacity across sites in America, Britain and Poland.
That explains why capital investment currently outstrips depreciation and cash conversion is not strong, but a £20.6m fundraising in May last year means the balance sheet has relatively little debt and operating income covers interest payments more than tenfold.
Operating margins and return on capital are both in the low double digits, as they need to be, since the business is capital intensive: in 2017 Zotefoams deployed £54m in plant and equipment to generate £70m of sales.
Even allowing for the costs involved in the capacity expansion, this means a good chunk of any extra sales should drop through to the bottom line, helping to embellish a streak of annual profit increases that dates back to 2013 and a string of dividend rises that runs to almost a decade.
The biggest risk is still probably posed by the valuation, despite the encouraging example of its rival Croda. There are few worse investments than a growth stock whose growth disappoints and there will be little to stop the shares falling in the event of any stumbles.
The full-year results, due on March 19, will hopefully tell us more. The lofty price-to-earnings ratio and low yield will inevitably deter value investors and income seekers but Zotefoams could put a spring in the step of those who like long-term earnings momentum.
Questor says: buy
Ticker: ZTF
Share price at close: 608p
Update: CVS Group
This column’s experiences with CVS, the veterinary services group, are one reason why it is approaching Zotefoams in what it hopes is a measured, risk-controlled way. In the case of CVS, we blundered in our original tip by mistaking quality for safety, and overpaying for growth, which to compound matters then failed to materialise as expected.
A third major profits disappointment since our initial look in May 2017 has prompted much painful introspection. The company warned that staff costs were rising much faster than sales as it has had to use locums to cover an industry-wide shortage of vets. A slow start at practices acquired in the Netherlands has not helped either.
We remain reluctant to sell and crystallise the loss, since demand for this vital service is clearly there, and now await the interim results on March 29. Meanwhile, there are at least a few sources of (cold) comfort.
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There has been some buying of stock by directors, albeit in modest size. Management has responded to the latest profit alert with the launch of a cost-cutting programme and a reassessment of the acquisition pipeline.
In addition, the shares now trade at less than 11 times forecast earnings. In view of last year’s takeover activity in the sector, when Mars Petcare bought Linnaeus and BC Partners acquired VetPartners, it will be interesting to see if that lowly rating tempts a predator to make an approach.
Hope is not a strategy, but the valuation means it may be worth giving CVS another (last) chance.
Questor says: hold
Ticker: CVSG
Share price at close: 448.2p
- Questor archive: telegraph.co.uk/questor