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I remember meeting the management of AIM listed CAD software stock Delcam (LSE:DLC) a few years ago and with the shares having almost trebled over the past 3 years to 810p I am a bit miffed that I did not get rather more enthusiastic. It is one of those companies where the shares never look cheap but then head sharply higher and so you always seem to miss the boat. I wonder if, with a market cap of c£65 million, it is not too late to buy a few.
The company had results this morning covering the half calendar year. At this stage I pass over to Paul Scott – a very sharp mind – for his take. Incidentally Paul’s website (http://paulypilot.blogspot.co.uk ) is well worth checking out and he can be followed on twitter at @paulypilot . Some folks are worth following on twitter ( have I mentioned @tomwinnifrith ?) and Paul is one of them. Paul notes today:
Pre-tax profits rose a stonking 67% to 2.1m for the 6 months, and basic EPS up 77% to 26.2p. Very nice indeed. That is on turnover only up 15% to 22.9m, so it’s a high margin business (gross margin is 67%), which is great when turnover is rising, but dangerous if sales prove sluggish. With software companies one also has to be very careful about one-off licence sales – how much of the revenue is recurring? The answer needs to be, “the vast majority” to interest me in the shares. From my cursory look, Delcam does seem to be heavily dependent on licence sales, which is a big risk factor. Someone who knows more about the company may be able to comment on this, and whether they are going down the more stable SaaS route, or not.
Strong cash balance of 12.6m, although as usual with software companies, some of that is up-front payments by customers (shown as a creditor called “deferred income”), therefore knock off that 6.4m to arrive at a true cash figure of 6.2m. There seems to be a pension deficit too, which is surprising for a tech company (as they are usually too young to have ever had defined benefit schemes) of 4.0m, so offsetting that against cash brings it close to net cash neutral, which is a more prudent way of viewing their balance sheet in my opinion.
They “remain optimistic for the full year”, and according to Morningstar that means forecast 47.4p EPS for the year, so putting the shares on a fairly warm PER of 17.
However, what looks really interesting, is that they are spending a huge amount on R&D – which can often be a precursor to seriously good/better performance in the future, once it feeds through to actual sales.
If I’m reading this right, they say that they spent 5.6m on R&D in H1 (that’s 2 & a half times their profit!), and it doesn’t seem to have been capitalised. If that’s correct, then the profit before R&D is enormously higher at 7.7m for the 6 months, which would make the shares look really great value.
The crux is whether that R&D really is R&D, which will reduce over time, thus boosting profits. Or, whether it’s just a normal cost of running the business, which they happen to call R&D. I suspect it might be more the latter, as software companies have to run to stand still, constantly improving the products or they quickly fall behind, wither & die.
Also, if they were really expensing that much genuine R&D, then surely the tax figure should be negative (due to R&D tax credits)? Which it isn’t. So at this stage, on first glance, I’m a bit sceptical about that R&D figure.
So overall, I’m intrigued. But on balance won’t be buying any, as it wouldn’t take much to trigger a nasty profits warning here – you know the type of thing, customers deferring buying decisions due to uncertain macro picture, which for a company heavily dependent on high margin licence sales, makes it quite high risk in the current wobbly macro situation.
Ends.
To answer Paul’s major points.
1. Around 30% of income is from maintenance contracts on licenses sold. The rest is dependent on new sales of software licenses. The company has an incredibly broad customer base ( 35,000 customers) but with exposure to China and automotive markets I would share his concern that looking into 2013 there must be a few questions about whether earnings growth can be maintained at historic rates. Since it operates via a re-seller model some of the blow on any slowdown in sales growth would be felt elsewhere. I note that the record of earnings per share since 2008 is 21.2p, 11.4p, 31.7p, 40.7p ( with 47.7p forecast for this year) and so a slowdown in the global economy ( as evidenced by 2009 numbers) would hurt.
2. The pension deficit came from an old defined benefits scheme which has now been closed. The deficit should have been down to £25 million by now with an agreement to clear that over five years. Sadly first half equity markets weakness has bit Delcam on the backside here. My guess is that the year end cash position will grow a little from here but that the deficit will ( ceteris paribus on the markets) be cleared within a few years. But I would agree that the cash mountain is more of a molehill right now. But Delcam seems good at cash conversion.
3. The R&D number seems to be pretty much the same each year. I would therefore suggest – and this is pretty much what I remember from my meeting – that this R&D is non-discretionary. That is to say it is needed to keep Delcam growing and whilst you might pare it in the face of a material slowdown in sales you could not slash it.
4. And so is the rating full? If 2012 numbers are hit (and given that we are almost in September and lead times for Delcam I reckon they will be) then you are paying a current year multiple of 17 for a business that will have delivered earnings growth of c31% per annum over the past four years. Were there no caveat over the the uncertainty concerning 2013 earnings this would be a high quality business on a PEG of just under 1 and I would have to rate it as a buy without hesitation. The caveat is however a real one. On that basis I think this is one to put on the watch list and wait for a day when the market as a whole is tanking. If you could pick up a few shares at closer to 750p then I would nibble.
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