- AIM-quoted firm sees margins disappoint in second half of 2024
- Management cites price competition and excess supply in the market
- Cost efficiencies have helped but net debt accrued owing to acquisitions potentially brings additional expenses
“Specialist audio-visual equipment distributor Midwich has substantially increased its revenues and profits since its UK market debut in 2016 as acquisitions have supplemented organic progress, but a mild profit warning suggests tougher times may lie ahead,” says AJ Bell investment director Russ Mould. “Management notes that the expected second-half recovery failed to develop in the second half of 2024 and that price competition increased as a result. Cost efficiencies and product mix have helped but earnings have disappointed all the same, to leave the shares at their lowest mark since early 2017.
Source: LSEG Refinitiv data
“The share price has been sliding for some time and peaked back in late 2021, just as Midwich really stepped up its acquisition drive. This may not be a coincidence. Management can point to the reward of higher sales and earnings, but investors seem to be just as focused on the risks, most notably higher borrowings.
Source: Company accounts
“More debt means more risk and a lower multiple of earnings for the stock, so even if earnings grow the associated de-rating could still check the share price’s momentum.
Source: Company accounts
“The company was still comfortably within its debt covenants so there is no cause for excess alarm, and interest cover was still nearly eight times in 2024. Midwich has also funded some of its purchases by raising fresh equity, as it did with 2020’s purchase of Starin Marketing and summer 2023’s swoop for S.F. Marketing.
“However, some businesses are more suited to carrying debt burden than others. The more predictable that revenues, profits and cash flow are the better, and the higher the profit margins are the better too (as that in turn underpins the cash flow that pays the bills).
“A distribution business with a gross margin below 20% and an operating margin in the low single digits does not meet those criteria with any degree of comfort, even if management is understandably pleased to note that the gross margin reached a record 17.1% last year.
Source: Company accounts, management guidance for 2024E
“There are many ways of measuring profit – gross profit, operating profit, pre-tax profit and net profit – but the one that really helps investors to gauge any degree of pricing pressure in the business is gross profit, as calculated by revenue minus cost of goods sold.
“Price pressures show through quickest here, even if cost efficiencies can help, and adjustments to sales and marketing, general and administrative and research and development costs can help to support operating profit, which is the ultimate guide to the health of a company and the strength (or otherwise) of a company’s business model.
“The good news is that analysts had already pencilled in fairly flat sales for 2024, around the £1.3 billion mark, and an 8% drop in operating profits – magnified to a 25% drop in net, after tax income, thanks to a higher interest bill, to again show the dangers associated with greater borrowing.
“The key now is what, if anything, management feels able to say about 2025 when the company reports its full-year results for 2024 on 18 March. Analysts currently expect a 4% increase in sales, a 5% increase in operating profit and a 15% recovery in net income, but any sustained price pressure or softness in demand could put those expectations in jeopardy.”
