Wednesday 17 December 2014

Dialight (DIA) ... here we go again?

Wednesday 17th December 2014

I reckon Dialight is a grossly overvalued business. All I see is a business capitalised at £255 million, with little in the way of IP, and a dismal record of free cash flow generation. For example, on my calculations it achieved a free cash outflow of £4.6 million in 2013, as compared to a paltry free cash inflow of £2.5 million in 2012. More recently, its free cash outflow looks to have been a further £1.1 million in H1 2014. Other investors may be more enthused by this achievement or believe that there is some actual IP in the business and that it can be protected. Nonetheless ...

I have shorted the shares at 785p/shr as I reckon DIA is lining up to disappoint for the second year running to deliver a second win: Dialight ... a dimmer switch?

In its Interim Management Statement (IMS) from 7th November 2013, the group stated that:

"As in recent years, the Group's financial results are weighted to the second half, and in particular the seasonally-strong fourth quarter. As ever the precise timing of Industrial Lighting orders remains difficult to predict, although the Group continues to expect underlying profit before tax from continuing operations to be broadly in line with the prior year."

In the event, profit before tax (PBT) from continuing operations was £14.4 million to 31st December 2013 (2012: £19.7 million) or 27% below the prior year. 

The company warned with a trading update on 8th January 2014, where it stated that the miss was partly driven by:

"... The late receipt of almost £3m of Lighting orders that will now be delivered in 2014 and decisions by certain US customers in December to defer Lightning orders will result in a shortfall against our previous expectations."

A further £3 million in the revenue miss was attributable to the Traffic business:

"In addition, the combined performance of the Traffic business both in the USA and Europe was also down £3m in revenues on the prior year."

Skip forward to this year's IMS from 19th November 2014 and the group's perfunctory statement regarding second half (and in particular Q4) weighted lighting orders remains. But this time there is a slightly different caveat: 

"... While any further major unforeseen disruptions to production could result in additional slippage this year, we are encouraged that underlying market demand is strong and production is running smoothly at this time."

We've been down this road before and so I don't place much faith in the group's assurances and visibility of earnings. 

While the group's revenue has grown strongly over recent years, by 12% YOY in 2012, 14% YOY in 2013, and a consensus expectation of 17.4% YOY in 2014, its EBITDA margin has fallen sharply. DIA's EBITDA margin was 19.5% in 2012, and fell to 13.6% in 2013. It fell further in H1 2014, to 11.8% as compared to 12% in H1 2013. And yet despite this continued decline in EBITDA margin, full year consensus revenue and EBITDA forecasts imply an improvement in H2 2014, to 15.6% from 15.0% in H2 2013.  

I reckon a year on year margin improvement in H2 2014, to be very unlikely. So I sold short and will await a trading statement in early January 2015. One's thing's for sure. If DIA disappoints for a second consecutive year, then its 21x P/E rating is toast. 

Dialight consensus sales forecasts
Source: Bloomberg
Dialight consensus EBITDA forecasts
Source: Bloomberg
Dialight consensus EPS forecasts
Source: Bloomberg
Dialight consensus net debt forecasts
Source: Bloomberg
Dialight share price
Source: Bloomberg
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  1. Stock tanked yesterday on a broker note. According to their trading statement they are inline with expectations, which is hard for me to believe...

  2. A bad result today, as the share price indicates. They are now barely break even on reported numbers and burned c5m (FCF) over the first half (now 8m net debt). Interestingly, trades still at 2x book for a projected 0% ROE this year.