Surface Transforms “has made a significant transition in the last 18 months, ” says Zeus Capital (LON:SCE)

Surface Transforms plc (LON:SCE) is the topic of conversation when Zeus Capital’s Research Analyst Robin Byde caught up with DirectorsTalk for an exclusive interview.

Surface Transforms are experts in the development and production of carbon ceramic materials and the UK’s only manufacturer of carbon ceramic brakes for automotive use. This week, the company announced a new contract award from a tier one supplier, the company calls OEM5. Joining me today to discuss the update is Robin Byde, Research Analyst at Zeus Capital.

Q1: Robin, as announced, the company’s announced its new contract award for OEM5, what can you tell us about that update?

A1: Actually, the company has made two quite exciting announcements in the past day or so.

The first, as you say, is that the group will now provide carbon ceramic discs for OEM5, which is an existing customer and a major auto manufacturer. Now, these discs will be fitted to an upgraded model of an existing vehicle, the start of production will be Q1 of 2024. The lifetime value of the contract is actually quite small, it’s just €5 million between 2024 and 2028 but the really significant thing about this is that this is repeat business, this is another contract with this high profile customer. Also, I think just to add to this, the company also announced just back in August that they’d won a £20 million pound contract with a new customer called OEM10.

So, the contracts are flowing with high-profile and, I believe, quite prestigious manufacturers. Overall Surface Transforms now have £65 million of OEM contracts in its pipeline for the next few years so it’s quickly making this transition from being an R&D house to being a volume supplier of carbon ceramic disc brakes.

Now, although these are great contract wins, they both start in some years’ time so we’re not changing our underlying estimates at the moment but what we have done is our longer term DCF valuation has been adjusted and we lift our target valuation to 85p from 80p so that’s about 25% upside.

That’s all good news on the contract front and the commercial rollout of the company’s products and then there’s a second announcement, which I guess is a little bit more technical, but also quite interesting as well.

The group has announced a revised manufacturing strategy and factory layout, this is to increase capacity, improve lead times and reduce the environmental impact of operations over time. So, the original plan was to build their factory, which is based near Liverpool, Merseyside, using separate production cells but what they’re going to do now, I think reflecting that they have more bigger contracts, is implement a more efficient plant-wide single production line.

Now, actually we visited the factory in July and discussed these plans with management and they’re quite exciting. One of the key benefits for investors is that factory capacity will increase more rapidly and the overall CapEx spend to fully build out the factory will reduce by £10 million to £40 million and that’s expected to generate £75 million of annual sales once the factory is fully built.

Q2: Is there further upside or risks to this story at the moment?

A2: Well, we think Surface Transforms will make more contract win announcements, that is our view. They’re gaining good traction with their customer base and gaining a reputation for producing high quality and attractively priced products.

I think probably the biggest downside risk is that this is a small company and a supplier to large OEMs so it certainly, for the moment, it will always be subject to the risk of delays in drawdown of discs by the OEMs. I think that’s probably the main risk at the moment.

I think looking in the rounds, this company has made a significant transition in the last 18 months, as I say, from being a research and development company to a volume supplier to the OEMs.

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