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Questor: Volex has delivered on its promise and the shares have soared. Should we hold on?
Questor IHT Portfolio: this cable assemblies maker has put its house in order and profits have responded – but shares don’t look overvalued
Apologies first. Normally on the first Friday of each month we publish our performance table. However, in recent months the odd error has crept into our table – errors that have been impossible to eliminate in the brief period between the receipt of the data from our provider and when the page has to be sent to our printers.
Our provider has been unable to give us correct closing prices for all our stocks with complete reliability. As a result, until we can find an alternative source, we will suspend publication of the table. This week has also been a thin one as far as news about the Income Portfolio’s holdings is concerned, so we will update on our Inheritance Tax Portfolio instead.
Update: Volex
This maker of cable assemblies has been one of our portfolio’s best performers. We tipped it at 82.6p two years ago and the shares now trade at 188.5p. It’s not hard to see the reason: profits have risen very strongly and, after a period in the doldrums, the shares have now caught up.
At the time of our tip in August 2018 the forecast operating profit for 2020 was $20m (£15m) but the actual figure achieved by the firm was $31.6m on an “underlying” basis.
Downing, whose Strategic Micro-Cap investment trust has about 16pc of its money in Volex, said the “quality” of the firm’s earnings was also improving. “When we began researching Volex in 2017 the adjusted operating margin was less than 2pc,” the fund manager said in a letter to investors this week. “In the most recent results it is over 8pc.”
It added that Volex had become far better at deciding where to invest. “Historically Volex had appeared highly cash consumptive, investing in the wrong projects with low returns,” the fund manager said.
“That has changed. There will be one-off capital expenditure projects required to support growth, but generally Volex is considerably less capital expenditure intensive than other companies we have encountered of its size. Working capital is also much more tightly controlled.”
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As we have written before, such discipline is crucial to delivering high returns on capital, one of the key indicators of a healthy business. In Volex’s case the result of its transformation has been, in Downing’s words, “improving, and generally very high, return on capital employed”.
In the most recent results the figure was almost 30pc, “which is high on both a relative and an absolute” basis.
Another of Questor’s favourite signs of a strong business is good conversion of profits into cash and Volex scores well here too. In fact in its most recent full year it generated operating cash flow of $51.7m, far higher than that $31.6m figure for operating profits, even if some of the excess was exceptional in nature.
Downing added that “management’s confidence in the group’s ability to continue to generate strong cash returns has been underlined by the commitment to the dividend”, which was 3p for the 2020 full year.
Although Volex has been affected to some degree by the pandemic it said in July that revenues and profits for the three months to June had been at last year’s levels.
Nat Rothschild, the executive chairman, said: “We continue to see weakness primarily in the medical installation sector, as hospitals around the world remain closed for non-critical medical procedures.
“In our electric vehicle business, demand is approaching pre-crisis levels as customers reopen their factories and consumer preference continues to shift towards electric vehicles. We continue to see resilient demand in our consumer electronics and data centre businesses.”
He said the firm had about $30m in cash and access to a further $30m in undrawn credit. Despite the strong rise in the shares they trade at a modest 13.9 times 2020 earnings.
Questor says: hold
Ticker: VLX
Share price at close: 188.5p
Update: Gama Aviation
We cannot be so upbeat about Gama, unfortunately. The aviation services business had plenty of troubles even before coronavirus came along.
Now the shares stand 84pc below where we added them to the IHT Portfolio on the strength of Downing’s large stake in the firm. The fund manager has now given up and crystallised its loss and we must face the music too.
Questor says: sell
Ticker: GMAA
Share price at close: 36p
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