Electrocomponents:Where can the turnaround go?

We lift outer-year estimates: see >10% margins by FY20e, but already priced in

    We assess how far profitability can recover: we raise our outer-year forecasts, increaseour price target to 490p, but remain Neutral. We see a c20% FY16-20e EBITA CAGR asmargins rise from 6.7% (FY16) to >10% by FY20e (last seen in FY12). This is supportedby both our benchmarking (significant underperformance still to unwind), andexecution (a strong, if short, track record from new management). However, valuationof 22x FY18e PE is a 10yr high – our forecast earnings recovery looks priced in. Theimplied FY20e PE <18x would see Electrocomponents in-line with peers, suggestinginvestors are equally expecting a return to >10% margins. We remain Neutral.

    What is needed to see upside in the shares? Gross margin recovery…

    Our scenario analysis demonstrates that earnings risk is well-skewed to the upside (EPS+30-50% vs. downside of -15%), but this is reflected in a valuation at all-time highs. Inorder to believe in further upside to the shares we would look for reasons to believeprofitability can become best in class. This would likely need a strong ongoing recoveryin gross margins (i.e. above UBSe +25bps y/y in FY17e, +10bps p.a. thereafter) as wellas continued cost control. This could drive margins >12% by FY20e.

    … and further growth acceleration

    We currently forecast organic growth to remain in a 3-4% range as restructuring andmixed cyclical conditions weigh on improved sales effectiveness. However, recenttrading has been stronger (+6% in 4mths to Jan), as management has targeted salesproductivity and customer satisfaction, as well as investing in key product lines.

    Returning to sustainable high-single-digit growth could be achievable, and is alsofactored into our 630p upside scenario (+39% vs. current levels).

    Valuation: DCF-derived PT now 490p vs. previous target multiple

    To reflect i) multi-year nature of margin recovery and ii) long-duration benefit ofimproved profitability, we switch to a DCF-derived PT from our previous 18x target PEbasis. Our FY17e estimates increased by 5% following the trading statement recently;today we increase our FY19e estimates by c3% and see greater uplift in the outer yearsas we build a stronger long-term margin recovery into our base-case forecasts.