UK Edition
Questor: buy translation firm SDL for its high barriers to entry, rising sales and improving margins
Questor share tip: SDL's technology and huge team of translators give it strong protection from competition
A good question to ask if you want to gauge how well a company is defended from competition is: how long would it take to build it from scratch?
If the answer is many years, potential rivals are likely to think that returns would be too long delayed to justify the cost and effort.
This week’s stock would take a long time to replicate. SDL, the translation firm, has been in business for 26 years and during that time it has built up a team of about 1,200 in-house translators and 16,000 freelancers.
“That kind of network takes a very long time to build,” said Stuart Widdowson, manager of the Odyssean investment trust. “That, on top of its proprietary technology, would impose high barriers to entry on any new competitor.”
In fact SDL has just two rivals of any size, along with a large number of smaller outfits. And in the translation market size confers advantages, Widdowson said.
He said the large multinationals among its clients – which include 88 of the world’s top brands – typically wanted to disseminate the same message in all their markets globally.
“The internet has brought about an explosion of content and companies want it to reach customers in more and more countries. That involves communicating in many different languages simultaneously, but managing that process is difficult as you will be using multiple platforms in multiple countries,” he said.
“A large firm such as SDL will have the resources needed – the process management software, the project managers, the automated translation engine – but smaller rivals won’t; they will be more geared to operating in one or two countries.” SDL has operations in 35.
As a result, its customers tend to stick with it. “It is the market leader and in some niches it has a market share of about 90pc,” the fund manager said.
Despite the business’s inherent strengths, there is scope for improvement. Widdowson said that in the past it had been “undermanaged” – “it was built via multiple acquisitions, which weren’t as integrated as well as you’d have expected”, he said.
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There is now a new management team, which is working to improve efficiency. “The company will use better ‘middle-office’ and ‘back-office’ technology. For example, until recently the scheduling of translators’ tasks was managed on a spreadsheet but there is now dedicated software in place,” Widdowson said.
The improvements should lead to higher profit margins. “The company is committed to a rise of 1-2 percentage points in operating margins every year,” he said. “They are now about 10pc but we think they should reach the high teens over time.”
When higher margins are combined with the growth in sales that Widdowson and the company expect, there is scope for double-digit earnings rises every year. As capital requirements are light, profits tend to feed through to cash generation. Odyssean expects the firm to be debt-free at the end of the year.
The investment trust likes to value this kind of stock in relation to its sales and said on this measure the valuation (an “enterprise value” of 1.1 times next year’s expected sales) was “not demanding” given the scope to improve sales and margins.
Questor says: buy
Ticker: SDL
Share price at close: 484p
Update: Galliford Try
Our advice to buy Galliford, the construction group, in August last year went awry when it was caught up in the collapse of Carillion. But Montanaro Asset Management, whose holding promoted our tip, said the firm was now “performing strongly on an underlying basis with very good progress towards its strategic plan”.
It said full-year results released in September were the proof: pre-tax profits were a record £143.7m and margins rose in all divisions. A total dividend of 77p, twice covered, implies a yield of 8.6pc, with a dividend growth target of 5pc.
To adjust for the rights issue in the spring, shareholders should multiply the pre-rights issue price by 0.89971. We tipped the shares at £13.29, equivalent to £11.96 today.
Questor says: buy
Ticker: GFRD
Share price at close: 893.5p
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