Little gems in the material world

Smaller Companies

SMALLER companies can often outperform larger rivals by being more flexible and by focusing on niche areas seemingly too small to interest giant concerns. Two examples in materials technology are Universal Ceramic Materials, at 104p, and Doeflex at 220p. While tiny in the context of their industries, they are big successes in world markets.

Universal Ceramic had a baptism of fire when the shares were floated in the summer of 1994. They opened at a reasonable premium but drifted steadily lower as the stock market suffered a severe bout of new issue indigestion. But they have picked up recently as investors come to realise that, helped by acquisitions, the group is becoming significant in its market.

Performance has been held back by weak prices for many of its products, but this could change as rivals drop out, shrinking global capacity while world demand is rising. Two large German rivals have pulled out.

The chief executive, Bob Hughes, is particularly enthusiastic about prospects for fused magnesia, the material used in heating elements. The group is the world leader in this market and has the capacity to handle extra demand. While the developed economies are relatively mature markets, there should be strong growth in Eastern Asia and the Third World as electrification spreads. The group is a significant exporter to the Pacific Rim and China.

Investors tend to associate ceramics with refractories - a mature market with high exposure to steel and the struggling construction industry. But the fine powders area of the business - with applications such as auto emissions, cutting tools and fabric spools - is growing fast.

The group is also strengthening its hand by acquisitions. Early this year it picked up the electrical grade magnesia assets of Tateho America. Then in June it announced it was in talks for the fused magnesia business of Pechiney Electrometallurgie in France. The French business has just 40 employees, but it could still be a significant deal: turnover was pounds l2m even when the business was operating at half capacity.

There is normally a slight first- half bias to Universal Ceramic's profits, but that may be different this year with a six-month contribution from the US acquisition. Based on the first-half pounds 1.45m, full-year profits should reach pounds 2.8m or better for a prospective price/earnings ratio of around 12 and a likely dividend yield of 5.4 per cent. In the following year profits could be in the range of pounds 3.3m to pounds 3.5m.

Doeflex is in specialised plastics and it is having a brilliant year, with first-half pre-tax profits up 60 per cent and a 54 per cent rise in earnings per share. The chairman, Richard Bickerton, talks of years of growth ahead at 20 per cent a year. But Doeflex could do even better. Observers have been greatly impressed by its ability to recover raw material price increases from customers in a wide range of end user markets.

The strong performance partly reflects recovery from years of recession. After years of growth (sales were pounds 2m in 1980 and should reach pounds 50m this year), profits stagnated between 1992 and 1994. Not helping were the acquisitions in 1992 of sheet plastic businesses in the UK and Belgium. These produced losses for longer than expected. The British business, Iridon, has now been restored to satisfactory profits and the Belgian firm, Horizon, is making a small contribution and set to do better.

Doeflex has illustrated the problems it faces with volatile price fluctuations. A typical example was a fall in one type of plastic from pounds 760 to pounds 450 between January 1989 and June 1994, before it rose to pounds 855 in June 1995 and then fell back to pounds 700 by September 1995. The group's view is that the fundamentals of tight supply and rising global demand will result in a period of consistently higher prices than earlier in the decade.

The main constraint on Doeflex is lack of capacity, and it is close to launching a large investment programme which is expected to secure significant organic growth over the next few years. Acquisitions also help, with the recent purchase of Plastech Extrusions taking forecast output on the sheet plastics side towards 20,000 tonnes, against 5,000 in 1989.

On forecasts of pounds 3m profits this year and pounds 3.5m-plus for 1996, the prospective p/e is 16 and the yield 3.5 per cent. This looks excellent value for a company set for years of fast growth.

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