Yahoo Finance Cheap stocks with no rivals and high margins are gold dust – and we've found one listed in London
This week’s American company is based in Florida, has its factory in Michigan and generates 80pc of its sales in either the US or Canada. It just happens to be quoted on Aim in London.
Somero Enterprises makes laser-guided machines that allow concrete floors and roadways to be laid with exceptional smoothness. It’s a niche market in which there are few direct competitors, so the company makes very high returns. Yet its shares trade on a single-digit multiple of earnings.
“Somero was the first to market laser screeding machines in 1986. They come into their own where there are fine tolerances – in robotic warehouses and high‑rise buildings, for example,” says Adam Rackley, who has 6.9pc of his Cape Wrath Focus fund in the stock. “The technology also gives you a faster, cheaper floor than traditional methods can.” He says there is also a big market in roads, which are often made of concrete rather than tarmac in North America.
The company’s aim is to keep its customers “for life” and Rackley says the small premium those customers pay for Somero’s equipment is “inconsequential relative to the cost of getting things wrong when you are laying a floor”.
Its hi-tech machines need regular and specialised maintenance, which helps the company to strengthen its links with its clients. It also makes money from training customers to use the machines.
“This is repeat business,” Rackley says. “It’s not sell and forget, it’s an ongoing relationship.” It’s the kind of business model, where price takes second place to the quality and reliability of the product, that allows for high profit margins – 35pc at the “Ebitda” level in the case of Somero.
The company is growing through the introduction of new products and by expanding into areas such as Australia. But it is striking that its expansion has been almost entirely organic. “It has resisted the temptation to make acquisitions,” says Rackley. “This makes sense given that it has the strongest brand in its field – buying Somero is like buying IBM.”
Two consequences of its aversion to acquisitions are a strong balance sheet and clean accounts, which tend to get complex when matters such as the “goodwill” involved in acquisitions have to be accounted for.
“The accounts have very few exceptional items and the company has a policy of maintaining a big net cash balance, which it adds to every year,” Rackley says. “The management team is extremely conservative.”
Once it has topped up its cash, anything left is used to supplement the ordinary dividend with specials or “modest” share buybacks, he adds. Cash flow is good – 80pc to 90pc of profits are converted into cash, depending on the measure used – partly thanks to the relatively low need for capital expenditure.
But returns on capital are truly exceptional: 65.8pc last year and an average in recent years in the mid-to-high 50s. Questor can recall only one figure higher among the stocks we have tipped.
All of this makes the valuation of 7.8 times its most recent annual earnings rather puzzling. “You could easily imagine a figure of 20 for such a stock,” Rackley says.
Why is it so low? We can in part blame the company’s low profile and its cyclical nature, tied as it is to the construction industry, notorious for its feast-and-famine nature. The market also took fright a few years ago when the weather interrupted construction projects and hit Somero’s profits and investors now seem to be pricing in a recession in America.
But Rackley says: “We are very happy holders of this stock. We have calculated an approximate fair value of 800p, compared with about 390p now. We see it as relatively low risk relative to the potential for big gains.”
Questor says: buy
Ticker: SOM
Share price at close: 388p
Update: Euromoney
This data and events business, tipped here two years ago, has finally agreed to be taken over by a consortium of private equity firms. You can’t fault the tenacity of the bidders: they had made earlier offers at £11.75, £12.50, £13.10 and £13.50 before the Euromoney board accepted their most recent offer of £14.61 per share. That figure represents a gain of 71pc relative to the 853p at which we tipped the stock.
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