View the article online at http://citywire.co.uk/money/article/a714715
City's love affair with Xaar endures after 200% rally
Nigel Thomas counts the producer of inkjet printing heads among a growing band of firms that are prioritising shareholder returns.
Xaar, the producer of inkjet printing heads that has enjoyed a 200% share price rise over the past year, is still a strong ‘buy’ say City analysts, while fund managers have been adding to their already large holdings in the Cambridge-based company.
Xaar (XAR.L), a recent entrant in the FTSE 250, is an ‘innovative’ and ‘disruptive’ company which is producing technologies that are being used to ‘reshape manufacturing processes’, wrote Ciytwire AA-rated fund manager Nigel Thomas (pictured) in his widely-read Thomas Report.
It is the dominant supplier in a ceramics market that is increasingly embracing digital printing, and has been growing sales in the packaging market in particular.
Thomas owns nearly 10% of Xaar in his AXA Framlington UK Select Opportunities Fund , which is a 'star pick' in our Citywire Selection list of fund recommendations. He has held the shares for over ten years and recently topped up his holding. He says Xaar counts among a growing band of companies that are paying more attention to long-term shareholder returns.
05 November 2013
Nigel Thomas, fund manager of the AXA Framlington UK Select Opportunities Fund
In the May edition of the Thomas Report, we commented that Washington and Brussels were equally reviled! Whilst politicians have ample opportunity to wreck an economic recovery, animal spirits will persist and perpetuate a business cycle. Even in the UK, as Disraeli remarked in 1852, “England does not love coalition.”
However, Simon Bond of Redburn Partners, one of our research-based stockbrokers, summed up the UK’s improving position rather well. “Having grappled with rising bond yields and the appearance and disappearance of tapering, the new curve-balls over stasis in the US budgetary process, and a mini profit warning from Unilever, refocused investors on the risk of both emerging markets and the foreign exchange component of company forecasts. When the UK becomes the Western world’s poster child economy, we know that these are still not normal times!”
UK permanent salary inflation is the highest since February 2008 and temp wage inflation is not far off a five-and-a-half year high. Vacancies continue to rise at pace and candidates’ availability has fallen further. This augurs well for many of our UK-centric companies. It is interesting to note that only 26.3%(1) of the All-Share Index aggregated revenues, by geography, come from the UK. The AXA Framlington UK Select Opportunities Fund holdings generate 30.3%(1) of their revenues from the UK.
Generally, low global growth and interest rates have focused attention on company returns. Shareholder value originally rose to prominence to solve what Adam Smith called the ‘agency problem’. This relates to the age old problem of managers or executives of a company potentially following a course of action that was favourable to them as a group, but detrimental, in the long-run, to the company’s beneficial owners – the shareholders.
The recent problems of the banks, before and after the credit crunch, illustrate this well. An asymmetrical risk exists between ever greater risk-taking by executives, to inflate annual bonuses, versus the shareholders’ long-term total returns, where, as a result, capital and dividends have been lost or forgone.
We are seeing more and more companies wholly embracing and aligning themselves with ‘total shareholder returns (TSR)’. This involves dialogue with shareholders regarding growth of earnings and dividends, special dividends and share buybacks. Companies we hold that, to use the words of that well known Private Eye gossip columnist, “Geddit”, are Next, Wolseley, ITV, Dunelm, St James’s Place, Rotork, Vodafone, WPP, Elementis and Rightmove.
We will not comment here on those that remain works in progress. We often remind investors of our investment mantra: “Things will not necessarily get better or worse, but will become different.” Citigroup produces good research on disruptive innovation and the growth of new industries: e-cigarettes, 3D printing, mobile payments, software as a service (SAAS) and the cloud, genomics and personalised medicine, solar energy and gas to liquids, to mention a few.
Xaar, based in Cambridge, with manufacturing facilities in Huntingdon and Jarfalla, outside Stockholm in Sweden, is in one such disruptive industry and is an innovative company. Xaar researches, designs and manufactures digital inkjet printing heads. These are being used to reshape manufacturing processes in a wide variety of applications including wide-format graphics, labels, packaging, ceramic tile decoration, decorative laminates and outer case coding. In terms of the decorative tile market, this is a global industry producing 10.5 billion m2 ceramic tiles(2) a year and is progressively moving away from analogue production to digital. Xaar believes it has captured 20% of the market and is converting 20% of the rest, per annum. Most of this manufacturing equipment is in Italy, Spain and China.
Another area of interest for its digital inkjet printheads is what is called ‘Direct to Shape’. Xaar has been working on this in research and development since 2006. As stated in Packaging Europe News, “Printing full colour images and text directly onto glass, PET and metal containers is a highly efficient process. It cuts out materials and inventory, reduces time to market and avoids many of the costs associated with using labels or sleeves. Images and text can be fully variable if required so that each container can be unique for targeted marketing campaigns or traceability purposes. In addition, decoration can be applied easily to irregular-shaped and textured containers which can pose a challenge for traditional labels and sleeves.”
Xaar has been collaborating with six German process manufacturing companies that, in September, exhibited products incorporating Xaar technologies at the Drinktec show in Munich. With labels often being a higher cost than the bottle, or even its contents, the cost saving using Xaar printheads would be similar to ceramic tiles. However, a tipping point is necessary for an industry to adopt digital printing. Xaar is growing fast and its share price has risen by 230% in the year to 15 September 2013. We hold 9.6%(3) of the issued share capital of the company in the Fund. This is a great example of how we invest in small companies and hold them for the long-term. We have held the shares for over ten years, have helped when they have raised capital to expand, visited its manufacturing plants in the UK and Sweden and seen off two takeover attempts, particularly from US companies. Xaar has recently entered the FTSE 250 Index.
We mentioned in the last Thomas Report that we had visited Booker’s nascent cash and carry business in Mumbai. Another growth strategy unveiled in the summer by the company is the roll out of its Family Shopper discount convenience store concept. It tries to combine the best of the hard discounters, such as Aldi, and the soft discounters, such as Poundland and tries to fill the gaps they miss. These are typically housed in 2000 sq. ft. stores, and 85%(4) of goods sold will come directly from Bookers, using its buying power and scale.
Change in any industry varies, especially when management teams are willing, or not, to embrace change. Retailers particularly demonstrate innovation and change when they are very close to, and can smell, the elephant in the room – namely the internet. The internet of all things is changing many things. Mobile communication is exploding as device-makers multiply. Filtronic plc, in a recent company announcement, commented that, “Mobile data traffic doubled during 2012 and continues to grow rapidly. Increasing numbers of data hungry devices – smart phones, tablets, e-books etc., require video. Video applications are projected to grow at 60%(5) per annum to 2018 and will represent over half of mobile data traffic by then.”
One of our successful investments that was borne out of the internet is Rightmove. It is the sixth most popular website in the UK and, during the first half of 2013, had 81% of market share online, compared to Zoopla with 16% and Prime Location with 3%. When they raised prices for estate agents again this year, only ten left in response. Housing activity has picked up and mobile access is coming through strongly – two billion mobile page impressions in the first half of their year, out of a company total of 7.2 billion. As mentioned above, Rightmove expects to continue to return all free cashflow to shareholders following payment of a progressive dividend. Very strong cashflow will also continue to fund share buybacks. As the management team commented to us recently, “What else are we going to do with the cash? We do not want to go into another online industry or geography.”
The largest holding in the fund is now ITV. We mentioned in the last Thomas Report that the investment was well timed in terms of its own recovery and that of the economy in general. National advertising revenue (NAR) for ITV looks like it could grow by 5%(6) in the fourth quarter of 2013 and is now expected to grow by 5%(6) for 2014. However, recent research from Credit Suisse has reinforced the attraction of its content, as produced by ITV Studios. Studios’ revenues from original commissions grew by 37% between 2010-2012 – the content pipeline probably having been replenished after a long period of underperformance when Studios’ revenues had fallen in the previous five years. Growth from distributing this content globally, where margins are estimated to be over 50%, would also add to profitability. Credit Suisse believes that if some of this content turned into global hits,like Downton Abbey or Mr Selfridge, then profitability would be significantly enhanced. Six recent bolt-on acquisitions bring optionality through diversification in terms of geography (three were in America), but also in terms of genre i.e. comedy.
The influences buffeting equity markets since 2007 continue. Peter Marshall, the British philosopher, when contemplating the past, commented, “When we long for life without difficulties, remind ourselves that oaks grow strong in contrary winds and diamonds are made under pressure!” Some management teams can cope with change and willingly embrace total shareholder returns. It is in these companies that we will try to allocate our investors’ capital.
Blackrock funds hold more than 15% of Xaar shares, a threshold they crossed in September after snapping up more of the stock. ‘The company remains well positioned and is looking at other markets for its print heads,’ according to a recent update from the BlackRock Smaller Companies Trust which counts Xaar among its biggest holdings.
The company is also the biggest holding in the Cazenove UK Smaller Companies fund . Managed by Citywire AAA-rated Paul Marriage and John Warren, the fund is another 'star pick' of Citywire Selection.
The ‘sell side’ also rate the shares highly, even after such a strong rally. Two analysts say the shares are a ‘strong buy’, one a ‘buy’ and another as ‘hold’. One area that the company is ploughing research money into, its Thin Film Piezo Technology has the potential to be a ‘step-change in technology,’ according to Investec analyst Thomas Rands, who is among the bulls on the shares.
The City is waiting on an investor day on 28th November for more clues on the company’s future.
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