Why fortune favours the lathes

In a typical stock market paradox, excellent recent figures from machine tool manufacturer and distributor 600 Group have pushed shares down to 276p from a peak of 301p. Any further decline, however, is likely to be short-lived and should be treated as a buying opportunity.

Over recent years, the group has been re-invigorated under the leadership of managing director Colin Gaskell and can anticipate years of strong growth, albeit not quite at last year's rate. His ambition to make 600 Group one of the world's leading manufacturers of high technology machine tools looks eminently achievable in a fragmented market. Three years from now, the shares could easily be trading at between 500p and 750p, the market believes.

Sales of the group's products are running at around pounds 70m out of a total turnover, up 25 per cent on last year, of pounds 146.3m. And more than 50 per cent of turnover has come from products developed in the last three years. The group's main line is lathes, which are used for machining metal parts. Lathe turnover doubled last year, with CNC (computer numerically controlled) and electronic models accounting for 60 per cent of sales.

CNC lathes are fully automated and targeted at larger customers. Electronic models assist in manual operation and are suitable for lower-volume operations. The group is on course to become the world's leading supplier of electronic lathes.

The group's other strength is its extensive distribution network, which has been expanded in recent years. Last year, domestic sales accounted for 31 per cent of the total, with increased penetration in North American and Far Eastern markets. Dr Gaskell's target is to have sales divided roughly into fifths between the UK, continental Europe, North America, the Far East and the rest of the world.

In many areas, such as Italy and Sweden, the group is starting almost from scratch but is building strongly. In the United States, where sales increased by more than 30 per cent to exceed $50m (pounds 32m), a network of super dealers is being developed to promote sales of CNC products.

The positive outlook represents a remarkable transition from the early 1990s when, like many manufacturing firms, 600 Group was battling to survive. One piece of luck was the sale of some development land to Tesco for pounds 10m just before the bottom fell out of the market. A similar windfall has just arrived with a cash payment to the company of pounds 15m from an over-funded pension scheme. The payment will virtually eliminate borrowings, which last year cost pounds 1.62m in interest charges.

Analysis of the group's results and prospects is complicated by annual pension credits and low tax charges because of large losses carried forward. Dr Gaskell says the pension credits are an accounting nonsense and should be ignored, while earlier losses mean the tax charge should be around 25 per cent for the next few years.

On that basis, analysts at brokers Warburg are looking for profits of pounds 15.5m for the year to 31 March, 1997, against pounds 9.9m last year, with pounds 19.6m expected for 1997/98. Implied earnings per share are 22.2p and 27p respectively, leaving the prospective p/e ratio at 12.3, then 10.1 - which looks excellent value.

Bald numbers, however, do not do justice to the potential excitement. The group has spent the past two years developing new products and launching them successfully in the UK. The strategy is to replicate that success internationally.

One result of 600 Group's success has been better trading margins, which have climbed from 5.5 per cent in 1995 to 8.7 per cent in 1996. This is hardly an outrageous figure for a group with a high, and rising, manufacturing content in sales and a substantial and highly profitable spares business.

Further progress on margins, allied to a healthy trend in sales, should give a "double whammy" to progress in profits, earnings and dividends. Throw in a re-rating for the shares and there is a prospect of a "triple whammy" to take the price significantly higher.

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