Electrocomponents PLC has the potential to become a $10 billion enterprise within the next 10 years but to achieve this lofty goal, the U.K.-based distributor must venture outside the electronic components market and put down big stakes in the larger maintenance, repairs and operations (MRO) market. CEO Lindsley Ruth set the stage for Electrocomponents’ transformation with a recent makeover but making it a market leader would require more drastic and visionary actions.
Ruth will have to convince Electrocomponents’ the board of directors that a more daring vision is realizable and potentially highly profitable. With annual sales currently in the $2 billion range, Electrocomponents is a bit player in electronic components distribution and MRO. The company estimates the combined addressable market at £380 billion ($484 billion), which means its share is today less than one percent.
There are no mysteries here about what the future holds for a small- or medium-sized enterprise in these huge markets. It will become an acquisition target for a hungry competitor. Ruth has told EPSNews in interviews since taking over as CEO in 2015 that Electrocomponents would explore growth via acquisitions and, more recently, hinted at other strategic actions in the company’s latest annual filing. However, the company has yet to announce a strategic partnership with any of its competitors in either the components distribution market or the MRO sector.
“We need to bring disruptive and strategic innovation to life in our organization,” Ruth said. “Industry 4.0, the current trend of automation and data exchange in manufacturing technologies, has the potential to transform the way our customers do things, bringing further exciting opportunities to grow our business. We need to make sure we are focused on identifying and capitalizing on these opportunities either independently or via collaborative partnerships.”
Electrocomponents must deliver on these promises if it wants to keep the lofty valuations it currently has on the equity market. The company’s market value has more than doubled since last June, rising 160-plus percent to a 52-week high 619.0 from a low of 236.40. Electrocomponents’ capitalization has consistently blown past the 12-month targets of analysts who track the company at research firms like Barclays, Liberium, Numis Securities, Peel Hunt and Shore Capital, forcing them to update their recommended price to institutional investors.
There are signs, though, that some analysts are becoming skeptical of the company’s ability to keep squeezing out benefits from its recent cost-reduction actions. This week, all the 10 brokerage firms tracking Electrocomponents placed a “hold” rating on the shares, reflecting the belief that its stock is now fully valued. In fact, the consensus 12-month price target of the analysts over the last year was 509.11. On Wednesday, the stock closed at 590, continuing its recent bout of wild price swings on general equity market pressures and profit-taking by investors.
Matched against the historical 5-year results, Electrocomponents’ recent performance has been exceptional. It has notched double-digit sales growth in a market battling the challenges of business digitalization, supplier and OEM consolidation, rapid product introduction and obsolescence and swiftly changing customer demands.
The company’s revenue strengthened 17 percent – as reported – in the fiscal year ended March 2017, to £1.51 billion ($1.93 billion), from £1.3 billion, in fiscal 2016. Profit attributable to shareholders also rose during the same period to £92.1 million, from £21.9 million, while gross profit margin climbed to 43.4 percent, from 42.7 percent. A sharper decline in operating costs drove up operating profit as a percentage of sales to 8.75 in the 2017 fiscal year from 3.1 percent in the prior fiscal year.
“These are the initial benefits of the changes Lindsley Ruth has introduced since being appointed CEO in April 2015,” said Peter Johnson, Electrocomponents’ chairman in the fiscal 2017 annual report. “There is much more to come. The coming year will see even more focus on how we can drive innovation into our offer faster and simplify our market approach further.”
While the company is bound to reap further benefits from its recent reorganization actions, sustaining the momentum will require more drastic actions. A closer look at the revenue figures indicate Electrocomponents’ sales have been propped up partly by external economic factors, including favorable exchange rates. In fiscal 2017, for example, underlying sales rose a less impressive 5 percent – after adjusting for trading days and currency movement. Nevertheless, this was an improvement upon the 2.8 percent and 3.5 percent reported, respectively, for fiscal 2016 and fiscal 2014. Further sales improvements are expected in fiscal 2018, according to Ruth.
“We have made an encouraging start to 2018, with continued strong underlying revenue momentum in the first seven weeks of the year,” he said. “We are using current growth momentum to accelerate investment in talent and innovation to drive faster growth in the business in the medium term. Work continues to identify further efficiencies and simplify the way we operate. All these actions mean that we are well positioned to make good progress in the year to March 2018.”
EPSNews believes Electrocomponents can continue to outperform in its various market segments. To achieve this goal, however, the company must invest heavily in a sector that has the potential to turn it into a market leader. Though the profit margins may be higher, Electrocomponents’ electronic components business is an unlikely candidate. If it wants to become an enterprise reporting tens of billions of dollars in revenue, Electrocomponents will have to direct more of its attention to the MRO market.
This doesn’t mean the company should abandon the electronic components distribution business. Far from it; the two markets are complementary.
EPSNews believes Electrocomponents should consider the following 5 key actions as it transitions from reorganization for profitability to a market-dominating enterprise:
- Strengthen Electronics Components Distribution Business but Limit Investments in the Segment: Electrocomponents is unlikely to become a major player in the electronic components distribution business unless the current top players trip and lose their footings. A few companies account for a large chunk of the market and they, including Arrow Electronics, Avnet, WPG and Future Electronics, all have revenues that are in the multiples of Electrocomponents' annual combined sales from both components and MRO. Rather than fight these giants, Electrocomponents should instead continue with actions to strengthen premium offerings to engineers.
- Acquire a Best-in-Class Medium-Size Distributor to Strengthen Electronic Components Business: Scale is important in any business and that’s what Electrocomponents lacks sorely in its two market segments. In the electronics component distribution business, it is a midget compared with companies like Arrow, Avnet, Future and WPG, all of which possess enormous resources useful for transforming operations and overcoming challenges inherent in their brick and mortar businesses. Electrocomponents can double its components business by merging with or acquiring a medium-sized but well-run competitor in North America. Such a deal would bring high-level industry expertise, complementary e-commerce knowledge and a fast-growing operation in Asia. The combination would shield the enterprise also from the vagaries of the MRO market, boost profitability, add supplier franchises and open opportunities in North America and continental Europe.
- MRO Acquisitions: The MRO segment is the larger portion of Electrocomponents' addressable market. The MRO market is valued at about £300 billion compared with an estimated £30 billion for the electronic components sector. Electrocomponents can lead the consolidation of the fragmented sector by acquiring smaller rivals and moving swiftly up the ladder. Suppliers and customers will benefit from the resulting cost-reduction, operating efficiencies and expanded offerings.
- Renew and Expand the Vision: Electrocomponents was foundering until Ruth arrived as CEO in April 2015. He has re-energized the company, emphasizing its strengths and eliminating many of its weaknesses. The company’s complex operating structure has been simplified but Ruth is in danger of getting swamped in process management. Ruth needs to continue the clean-up but he must also unfurl a more compelling vision for the company.
- Appoint a Senior Operations Executive: We suggest the appointment of a seasoned and process-oriented executive to work on the turnaround program and improve the company’s market position. This will free Ruth to concentrate on building supplier alliances, strategic mergers and acquisitions and work on expanding the enterprise vision into new or adjacent markets. The longer Ruth must manage Electrocomponents as currently constituted the faster his energy drains into the swamp of day-to-day business engagements, further eroding the enthusiasm he has sparked amongst suppliers, customers and investors.
Bolaji Ojo is editor-at-large and publisher of EPSNews. The views expressed in this blog are those of the author alone who promises to base his sometimes biased, possibly ignorant, occasionally irrelevant but absolutely stimulating thoughts on the subjective interpretation of verifiable facts alone. Any comments should be sent to the author at email@example.com.