Somero Enterprises Inc (SOM.L)
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Somero Enterprises Inc (SOM.L)
Market leader with near monopoly in a niche industry
The following article is NOT an investment advice!
There will most likely always be a market for building new structures such as warehouses (this is a growing area), parking lots, shopping centres and the like. These all require large perfectly flat floors. Somero Enterprises has the right solution - and not much competition.
They design, assemble, sell and re-manufacture equipment for laying large level concrete floors. They also developed some other innovative equipment for the building industry. They are listed on the London Stock exchange, but they operate and majority of their revenues come from the US. They are expanding internationally but they are mostly successful in the West.
The business is fairly simple: sell the equipment and services to the build contractors - mainly for warehousing, parking structures, retail centres and similar where large and perfectly flat floors are required. They place big emphasis on training and after sales services. This may be part of their competitive advantage in that once an operator (their customers are usually concrete floor specialist contractors) learns to operate their system, they may be reluctant to switch. The market is a niche one. There are not many similar manufacturers in the US (eg ligchine.com which is private and seems much smaller). There are obviously some knock-offs in China but without service and training these will find it hard to compete in the West.
They are not a big enterprise - their market cap is around £250m ($298m) but they keep growing revenues and net income steadily. They also have no debt and had some $42m in cash at the end of 2021.
They command very high gross margins - over 55% consistently. This may be because they seem to focus on the parts of the business where they add value - namely design, assembly, selling and support. They most probably have parts manufactured by sub-contractors although they don’t mention that explicitly.
Research and development + IP
They come up with a couple of new equipment designs every year or so. They also introduce a new product or two to the market every year. They claim they design and build their equipment in consultation with the customers which would be a great sign. The latest addition is a departure from the concrete floor focus but still within the building industry - SkyStrip: Plywood Sheet Stripping Machine which saves contractors a lot of effort. They have dozens of patents protecting their IP and they don’t shy away from infringement litigation.
Geographical Reach
Most of their revenue comes from the US - 80%, Europe - 10%, Australia - 5%. They are trying to expand mostly in the West. They have largely given up on China - they believe there is little demand for quality from the local contractors.
Growth
They could grow substantially in Europe and by introducing new products. It would seem that introducing new products to existing customers would be the easier way. As mentioned above they are introducing new products but acknowledge that where a completely new application is introduced the take-up is initially slow.
Risks
The CEO (John Cooney) who has been with the company for 20+ years and done a superb job is likely to step down at some point. The likely successor John Yuncza has been with them since 2015 so is not an unknown entity.
The US/world economy could tank - not much we can do with that.
Valuation
On a simple model of free-cashflow discounting they (current free cash flow of around $30 mil) could be worth anywhere between $700m to $1500m to a buyer in a private transaction based on different assumptions of growth and final sale value. They have historically grown their revenue and free cash flow by about 20% obviously with substantial ups and downs year on year.
In other words as per scenario 3, currently the market thinks that the company will not grow its revenue and free cash flow at all and would be sold at just four times cashflow in 10 years time which sound a bit pessimistic.
Other
They maintain a healthy dividend (5.5%+) and they keep on buying their stock back (although this mainly to finance the issued options) - that way they returned $23m back to shareholders.
Return on equity and capital employed are both high at 30%+. It trades currently at under P/E of 9.
Catalyst
If the company keeps on growing at least the intrinsic value should increase in line with revenue and net income growth. Worst case would be to just collect the dividends and wait for the intrinsic value to increase over time. Perhaps, if the inflation worries subside and construction keeps on growing, it could re-rate accordingly. It could also easily become a takeover target at which point some of the value should also crystalise.
Additional resources
https://www.thequalitycompound.com/post/somero-foundations-for-growth