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Questor: shares in this Aim stock have quintupled – this is why we are not selling

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Cables - Bloomberg
Cables - Bloomberg

No Questor Aim tip has performed anything like as well as Volex. Shares in the cable maker have more than quintupled in the three years since we added them to our Inheritance Tax Portfolio. As ever in these circumstances we find ourselves wondering if the share price has got ahead of itself and we need to sell before bust follows boom.

Nick Hawthorn is in a good position to help us decide. His employer, Downing, is one of the largest shareholders in Volex and has excellent access to the company’s management team – “we speak to them at least once a fortnight”, he says.

This column is a strong believer that actions speak louder than words and Hawthorn’s are unambiguous: Volex is the largest holding in both the Downing Strategic Micro-Cap investment trust – at a highly unusual 17pc – and the Aim portfolios the firm runs on behalf of clients who, like readers of this column, want to minimise their inheritance tax bills.

“It was a high-conviction holding three years ago but we have even more conviction in it now,” he says. The company has performed “exceptionally well” during the pandemic, according to Hawthorn, but he says there are many reasons to expect more.

“I think it can continue to benefit from its ‘buy and build’ acquisition strategy,” he says. “There’s a huge number of ‘mom-and-pop’ outfits that Volex can consolidate. It tends to buy them on cheap multiples such as six to eight times Ebitda [earnings before interest, tax, depreciation and amortisation] whereas Volex itself is valued at 12-15 times Ebitda.” Those businesses therefore become immediately more valuable once they are part of Volex.

“We expect the company to produce at least $30m (£22m) of free cash flow a year and it also has bank loan facilities, so even after it has paid its dividend it should be able to fund one or two new acquisitions a year,” Hawthorn adds.

Volex is also one of the biggest suppliers of cables to the electric vehicle market. “The electric vehicle arm made $50m of sales last year at a margin of about 10pc, the group target, and management has said it expects $70m this year,” he says. “We think this is too low because it ended its 2020-21 financial year at a rate of $8m a month.”

Prospects also look bright for the company’s healthcare division, which supplies cables for scanners. Hospitals need more scanning capacity to help clear their backlogs but installation programmes have been disrupted by the pandemic, Hawthorn says, leading to an even bigger need to invest now. “Philips Healthcare, which Volex supplies, has experienced a 30pc increase in order intake coming out of Covid and lockdowns,” he adds.

Finally, the firm has a strong position in high-speed “active” cables for use in data centres, where the need for ever greater speeds has shortened product lifespans from about six years to two. “Volex has an installed base to upgrade here, although management has not talked up the opportunity much,” Hawthorn says.

How much of all this positivity is already in the share price? “The market pays a premium for successful and scalable ‘buy and build’ strategies. We think that discoverIE, the electronic components maker, runs a comparable strategy [it announced two acquisitions yesterday] and its shares currently trade at about 35 times earnings; Volex is at a little over 22 times on our numbers,” he says.

“We think the shares are held back because investors still remember Volex’s past: its years of underperformance when the previous management couldn’t make it work, when margins fell even as sales rose. It is now a much higher-quality business.”

The firm’s bosses also seem to think the shares are undervalued, judging by the £238,000 purchase by the wife of the chief operating officer last week.

Even after the shares’ very strong run, we will hold.

Questor says: hold

Ticker: VLX

Share price at close: 442p

Aim news

Dividends paid by Aim companies recovered strongly in the second quarter of 2021 after a severe decline last year: they grew by 56.6pc (excluding special payments) compared with the same period of 2020, according to Link, a financial services firm. Link said it expected payouts to rise by 24.2pc, excluding specials, in the second quarter, and by 21.9pc over the full year.

Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.