What does the company do?
In recent years, DiscoverIE has evolved from a distributor of electronic components to an international designer, manufacturer and supplier of customised, differentiated electronics. The strategy is to focus on generating organic growth in four target markets, where their products should see increasing demand over the longer term. Organic growth is supplemented by acquisitions, to broaden the product portfolio and geographical reach within these markets. The key to success is to focus only on growing markets that are underpinned by structural shifts. Management identify these as renewable energy, transportation, industrial & connectivity and medical. By operating in these growing markets, organic revenue growth should be well ahead of GDP over the economic cycle, and create acquisition opportunities.
The group operates in two divisions Design & Manufacturing (D&M) and Custom Supply (CS). The D&M division supplies custom electronic products which are uniquely designed or specifically modified from an existing product to customer specifications. Most of the products are manufactured in-house, the rest manufactured by approved third-party contractors. The strategy is to grow this high margin division. 15 acquisitions have been made so far and the division has developed from a UK business in 2011 to a global one operating in 23 countries. The Custom Supply division provides technically demanding, customised electronic, photonic and medical products to 20,000 industrial manufacturers. The products come from a range of high quality 3rd party international suppliers and from the D&M division. The division operates similarly to D&M, but mostly with products sourced from 3rd party suppliers rather than manufactured in house.
Once approved, products are designed in to customer solutions, typically generating repeat revenue for the lifetime of the customer’s production. Repeating revenues, combined with the conversion of customer design wins from new projects drives the order book. A key strategic focus is cross-selling between the businesses to broaden the range of products, develop stronger relationships and increase sales efficiency.
The management’s focus on markets with long term thematic growth drivers is key to the quality aspect of growth, and removes cyclicality. In renewable energy, growth will be driven by wind and solar power reaching commercial viability. Transportation will benefit from increasing regulation and investment in rail, along with electrification infrastructure which remains underinvested. Industrial connectivity plays into increasing connectivity and wireless communication. Drivers in medical include an ageing and increasingly affluent population.
Why do we like the investment?
We like the capital light business model and the visibility you get from the ‘designed in’ nature of their products. There will be margin progression from here achieved through operational gearing from above group average growth in the higher-margin D&M, alongside higher margin acquisitions. The balance sheet is strong, supported by healthy free cash generation for future acquisitions.
The business has an excellent track record of growth since 2011, attributed to their unrelenting focus on their target markets. We hold management in high regard, they have an impressive track record of meeting long term targets and extending them. They have the right strategy in the right markets to continue to improve their margin profile and drive growth. Growth comes from being in the right markets with strong structural drivers and from M&A. The market for customised electronic components is extremely fragmented. It consists of many sub-scale designers that lack the distribution channels to unlock their full value. Management have taken advantage of this and made 15 acquisitions of varying size to date to strengthen the group. With a strong track record in M&A, the next step is to self-fund acquisitions. The opportunity remains to continue expanding in current geographies and into new ones, to build a larger global electronics group.
Discover IE’s dividend policy is progressive. While at this stage in the company evolution there is a bias towards growth over income, management acknowledge that investors value dividend returns and so will look to grow it roughly in line with earnings per share growth. It was impressive to see DiscoverIE issue a strong update despite the Lockdown, illustrating the resilience of the business model. We hope that their global footprint will help to drive market share gains in this environment, with smaller peers unable to serve customers on the same international scale. The pandemic may well accelerate some trends in their four focus markets and may also provide acquisition opportunities. With the backdrop of global fiscal stimuli and investment in infrastructure (notably 5G and renewables), this should help provide a tailwind to organic growth.
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