Somero Enterprises: rock solid

Why I’m taking a position in the concrete screeding equipment-maker

Photo by Nana Smirnova

You may have heard Michael and I discussing Somero on last week’s Investability podcast as the subject of our weekly Deep Dive, where we invite listeners to tell us what companies you want us to talk about.

I’ve you haven’t listened to our chat you can do so here. But for those that prefer written tomes to our dulcet tones, I thought it would be useful to compile our thoughts each week.

What it does

Somero’s business is on the face of it a simple one – it designs and makes laser-guided machines and software that builders use to level horizontal concrete slabs and screeds and trains its customers how to use them.

Using these machines mean builders can be more productive, speeding up installation and lowering the cost. Laser screeding also achieves flatter floors, which is particularly important in industrial applications such as warehousing – the high racking used in most modern logistics can’t be built on uneven floors (imagine an accident involving the boxes in the picture above), and the air pallet-jacks needed to move goods around need perfectly flat floors to operate on, as do modern automated warehousing robots.

Current trading

Unsurprisingly, then, the current trends towards e-commerce and shortening of supply chains – the so-called shift from “Just-in-Time to Just-in-Case” that’s happening in response to the supply chain crunch we’ve experienced this year – are proving very good news for Somero, helping it bounce back very strongly from a pandemic-blighted 2020 to comfortably beat 2021 revenue, EBITDA and net cash expectations at $133m, $48m, and $42m respectively, in each case $3m ahead of previous forecasts.

Sales in the key North American and European markets grew 50% and 40% from 2020, and Somero said its customers were seeing project backlogs extending well into the current year. That chimes with what we’ve been hearing about the non-residential construction market, where industry is building as quickly as it can to offset a shortage of high-quality logistics space.   

A key component of Somero’s strategy is the development of new products to broaden the markets and applications it can sell to, so it’s also encouraging to see a good level of sales from newly developed products like its SkyScreed product for high-rise screeding. But that strategy can also dampen profitability as profits are reinvested, and why the company expects EBITDA comparable to 2021 in the current financial year – we’re comfortable with that as history suggests it will provide a foundation for accelerated growth over the longer term.

The bear case beware cyclicality

The one negative in the latest trading update was news of a weaker performance from its Chinese business, where full year revenues slipped 30% on 2020. The company had been targeting the country via the Western multinationals planning to expand there, but after slower than expected growth is now reassessing its Chinese operations and reducing its cost base. That’s sensible given well publicised troubles in the Chinese property market, and the growing likelihood that Western companies retrench from the region. Luckily, sales in the country only account for less than 3% of total revenues.  

However, it does highlight the broader economic trends Somero is exposed to, not least the inherent cyclicality of construction. Interest rate rises could also dampen the property market, as could a slowdown of the e-commerce trend or even adverse weather conditions in its key markets, which have disrupted business before.

Nevertheless, those risks are comfortably offset by a forecast PE ratio of 11.4, which falls to less than 10 for 2023, and a dividend yield approaching 6% highlighting the group’s ability to invest in growth and generate excess cash simultaneously. Net cash balances also continue to rise, which could prompt special dividends or fund bolt-on acquisitions.

The bull case: quality shines through

There’s a reason for this ability – this is a business that, despite the cyclicality of its end markets, scores very highly on all sorts of quality metrics. After breaking into profitability in 2012, operating marginss have risen steadily and are expected to rebound to almost 35% in 2021, according to FinnCap forecasts. Gross margins of around 57% are indicative of an efficient manufacturing base, which means a good drop through rate of revenue to profit, and high returns on capital which are expected to rebound to more than 50% this in 2021.  

In fact, we’re finding it very hard to find anything not to like about Somero, beyond its obvious exposure to cyclical constructions trends. It doesn’t appear to have any significant competitors, and because it’s so specialised – with lots of know-how and intellectual property – it’s unlikely to attract any new competition in its niche – the so-called WD-40 effect in action.

The shares have ten-bagged since coming to market, and its hard to imagine we’ll see a repeat of that. But the dividend yield is attractive, and a 20% pullback from all-time highs mean there’s enough in the shares for me to take a position.

And do please keep the deep dive ideas coming!

Somero’s key financials and ratios

Source: SharePad

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