Gooch & Housego “attractive at the current share price” says Zeus

We think Gooch & Housego is attractive at the current share price and initiate research coverage with a valuation of 1,150p, indicating c.30% potential upside. Manufacturing is gradually recovering from COVID and supply chain disruptions, and the orderbook is now at record levels. Recent H1 results were mixed but the strength of the recovery in orders, particularly for industrial lasers, combined with abating disruption, prompted management to continue to support full year consensus earnings estimates. The long-run potential for photonics technology is undiminished, our analysis shows that demand across industrials, medical, communications and defence industries will significantly exceed global GDP growth rates. Gooch’s fundamentals are strong, and it now has a war chest to execute tuck-in acquisitions. The valuation is attractive, trading on a c.30% PE discount to its own historic long-run average PE metric, and a c.25% PE discount and a c.30% EV/EBITDA discount to the quoted global optics and photonics technology sector.

Record orders but H1 somewhat subdued with disruption – H1 revenue and profit continued to be hit by COVID and supply chain disruption. Revenue was down 7.4% to £54.1m with lower volumes. Adjusted PBT of £3.6m was down 26.6% with lower sales but also due to ongoing and necessary investments in R&D and manufacturing capacity. Although subdued, revenue and profit were in-line with our expectations. As with other manufacturers, working capital and inventory levels were elevated to secure supply, but net debt was only up modestly (e.g., pre-IFRS 16 £5.9m vs. £4.7m in H1 FY21a). Indeed, the Board felt confident enough about H2 and the general outlook to lift the interim dividend to 4.7p vs. 4.5p last time. A new five-year debt facility was established, and this allows over £30m of headroom for tuck-in acquisitions. Overall, Gooch & Housego reported solid H1 trading despite, largely residual, disruption to operations and the supply chain.

Outlook cautious but positive – Management was cautious but positive in their statement, and full year expectations (reflected in market consensus and our estimates) were guided as unchanged. Orderbook growth (up c.29% to a record £119.9m) reflects reportedly strong and sustained demand across all Gooch’s target markets. Orders included significant wins for the next generation of products in acousto-optic modulators, electronic optical sighting systems and medical lasers. Substantial additional manufacturing capacity has been added in the UK and USA to service the semiconductor, medical laser, and aerospace & defence markets. This is timely; as our analysis shows, demand for optics and photonics products is likely to significantly outstrip global GDP growth over the medium-term. More immediately, Gooch also reported that, early into H2, manufacturing activities and operations are normalising, hence the confidence expressed in full year expectations.

Zeus estimates and valuation – Our estimates have been reviewed by management. We assume a strong recovery in profit to the year-end (i.e., FY22e Op. profit +c.58% to c.£11.8m). This reflects rising end-demand but also the benefits of restructuring and outsourcing of some manufacturing activities. Demand for industrial lasers is expected to lead the continuing recovery but with aerospace & defence likely to lag with programme delays. Cash should improve with better trading and some abating of working capital pressures. Returns and free cash (i.e., RoNA, FCFY) are weaker than we would like but should improve with trading and a working capital unwind. On acquisitions, we calculate that the £30m+ war chest could generate an extra £20m of additional sales and, say, £4m of EBITDA, or a potential 20% upgrade. Our DCF-based valuation is 1,150p, and Gooch & Housego is attractively valued when measured against its own historic long-run average forward PE metric and the wider photonics technology sector.

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