Every three months, FTSE Russell reshuffles the FTSE 100. Unlike the S&P 500, its a fairly rules-based approach according to the market caps of Premium Segment equities in the London market.
This means stocks entering the FTSE 100 are likely to have had some momentum, or at the very least relative outperformance.
One company that has caught my eye in the December reshuffle is Electrocomponents PLC (LSE:ECM), a global omni-channel solutions partner for industrial customers and suppliers. The company provides industrial and electronic products and solutions. It was started in 1937 as a business selling parts for radios. Now it works with over 2,500 suppliers and provides over 650,000 items. Essentially, it is a one-stop shop for designers, builders and industrial equipment operators.
Management believes its total addressable market is around $400 billion and is growing faster than gross domestic product. The market is very fragmented with the top 50 companies in this area accounting for about 30% of the market, according to Electrocomponents. The company has less than 1% global market share and about 5% U.K. market share, its home market.
Most players in this market are smaller, local companies, whereas Electrocomponents has 12 distribution centers around the world serving 80 countries. Its broader product range and global market presence give it a scale most competitors cant match.
CEO Lindsley Ruth arrived in 2015 and turned the company around after the devastating impact of the 2008-09 crisis. Under his leadership, the stock has gone from 2.30 pounds ($3.06) to over 11 pounds currently. Part of that growth was the companys entry into services, helping customers design, procure and maintain equipment. These services are a sticky revenue source, so the tailored solutions make Electrocomponents a preferred supplier and add high switching costs for customers. These value-added services have also helped increase adjusted operating margins from 6.7% in 2015 to 12% in the companys most recent half-year results.
Even with Covid-19 disruptions, the company is targeting adjusted operating profits in the mid-teens, and I think 14% is achievable by 2025. Thats because the company is focusing on growing higher-margin own brands, such as RS PRO. This is all part of the Destination 2025 growth strategy, the companys vision to be first choice for all its stakeholders. Other targets in this self-help program are expanding the value-added service offering further and improving the efficiency of its operations through automation and increasing scale in distribution centers. Also, heavy supply chain investment should create more efficiency and a more sustainable business that will aid managements ambitious growth plans. Another component of the self-help is the RISE program to simplify the group.
For contrarians, one risk to the Electrocomponents investment story is that the Street is very bullish on the stock. Earnings upgrades based on improving operating margins have gone hand in hand with stock price performance, and shares are essentially flat since last months half-year results. This may reflect recent selling pressure, after a rally on the half-year earnings, from fast money investors who front-run index buying on FTSE reshuffles.
Another reason I am quite interested in this stock is its very strong Altman Z-Score, which stands at 5.72. This gives management leeway to make acquisitions to keep the growth story intact. The fragmented nature of the industry means there are plenty of smaller competitors that could be rolled up into the business. Management said recently there were a number of active merger and acquisition opportunities it is considering.
Targeted acquisitions could help smooth out some of the more cyclical elements of the companys portfolio, which would help the company weather the inevitable downturn global economies must one day face when interest rates eventually rise. Currently, Electrocomponents is significantly exposed to the manufacturing sector, which makes up just over 50% of its customer base.
The stock has had significant momentum in the last 18 months, so the GF Value Line suggest the stock as significantly overvalued currently.
This stock goes on my watchlist. I will be monitoring the self-help program and the M&A activity carefully and might potentially buy the next dip.
This article first appeared on GuruFocus.