Volex (VLX): Pegged Back

Note: for the graph to the right, I've taken their reported figures (now in USD) and restated them in GBP as their previous results were. The graph is in GBP. The results are now in USD.

Volex (LON:VLX) are a company I haven't heard about or looked at before. This is nice. Given that the market is going up, it strikes me that there are more potential stocks leaving interesting territory than entering it - and by interesting I mean cheap - and there's a whole lot of chaff I don't want to sift through to get to something potentially interesting; speculative mining shares and financially engineered contraptions seem to litter the place.  I only have to look at the share price chart to see where I want to begin here, though; three huge jumps in price jump out at me, and I think understanding those should help me understand the business.

What they actually do, to begin with; at the most basic level, they make cables and wiers for data/power transmission. Can we call this a growth market? I guess we can; electronics is probably the growth market of the last half century, so it makes sense that the building blocks of the electronics we all hold dear are also vital. Commoditisation is a worry, of course, but perhaps this is somewhat tempered by the rate of progress; this isn't like tires, milk or bread. Fibre optic cables, as an example, seem like the next big thing - and improving the components seems to go hand in hand with improving the experience for the end-user. If products are constantly evolving, there's a premium for those who can keep up. Volex try very hard to sound like a cutting edge and integrated company - they highlight the precision nature, and the fact service and reliability is vital given the value of the end products.

The two recent bumps

Looking at the share price chart, there's obviously been some action taking it down into cheap-looking territory - and it doesn't take a genius to guess that those big downward plunges in the last year were profit warnings. Indeed, the company; which, judging by the chart above, has been on a steadily rising trajectory, rather disappointed the market by noting in September that:

In light of a recent unexpected change in forecast demand from the Company’s largest customer in its Consumer sector and the continuing adverse macro-economic conditions, the Company now anticipates that revenue and profit for the year ending 31st March 2013 will fall short of Management’s prior expectations

Cue a 35% price drop. They went on to note that they expected operating profit to be 'broadly in line with that of FY2012'. If this was me in September, I'd be somewhat reassured: last year was a good year, and a continuation of that level of profit certainly doesn't have the company looking expensive. For interest, that 'largest customer' is apparently Apple - though I can't reconcile the '30%' figure in the article I've just linked with the annual report, so take that with a pinch of salt. It is probably a bit of a kick in the teeth for Volex having noted in their annual report that they'd made 'substantial investments' in this relationship, though. Oh, the ruthlessness of capitalism...

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Still, shoot forward to December and the board announced that their previous expectations were perhaps a little optimistic. We are now looking at revenues of more like 10% down from last year, with operating profit more than halved. Naturally, the share price tanked even further, to roughly where we are today. That's how we got here; but does it now present good value?

A bit further back

To get to that question, we need to take a slightly longer term view; that's why I mentioned 3, not 2 price jumps I wanted to look at. The first, if you see the chart, is that colossal ramp up in 2010. What caused that? It's likely to be a number of factors, but I suspect the main overarching 'mood' is the sense that the company had turned around its fortunes. For years it had been restructuring and earning weak (well, predominantly negative!) returns on capital - but from '09 onwards, returns soared. It once again looked like a growth business. There's a nice quote from a 2010 FT article which sums this up, noting its rather less glorious decade compared to its FTSE 250, £1bn market cap status pre dotcom bubble:

“The business was very much in survival mode during the last decade,” says Ray Walsh, who was bought in as chief executive in 2009 after the group issued three consecutive profit warnings in 2008. “Much of the period was spent on the back foot. There was no focus on topline growth.”

The simple fact is, my graph in the top right is a 'normalised' view of reality - but what is normal reality? The group, following years of restructuring, appeared to finally hit some good form and started delivering profits instead of losses - returns above the cost of capital, even. I'm not particularly comfortable making any valuation based on the last few years' figures, though. Realistically, we need to account for a far longer time frame - all those years of restructuring, too. It'd be naive to assume that we've washed our hands of the nasty 'one-off' charges - if we accept this is a competitive and fast moving industry, this stuff is hardly unexpected.

The profit warnings just compound all of this. It's not an easy industry to be in, and I have no idea how to value something as uncertain as this. It looks interesting, but there's nothing I can grasp that gives me any tangible understanding of what to value the business at. Profits are all over the place, returns are all over the place and it doesn't strike me as a hugely defensible market for incumbents, though that might simply be my own lack of knowledge. Either way, I'll steer clear.