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Judges Scientific: tangible upside for a long term investor?

With the world’s equity markets displaying the kind of volatility we have observed in the last twelve months, it is no wonder that investors are looking for safety in places traditionally considered less volatile, such as education, pharmaceuticals or precious metals. Such is the investor appetite for gold, for instance, that you see sellers lapping it up by advertising the metal in newspapers with bullion photos slapped across the page.

The rush for the precious metals is, in my view, poorly justified. Since investing is most profitable when viewed as long term, the period of extreme market volatility presents investors with equity buying opportunities on the scale not seen before. Therefore, investors must be searching to park their capital for the long term, among smaller size companies with conservative management and competitive product market positioning. Investing in equity in such manner may well prove a much better capital preservation strategy five years down the line than buying up precious metals.

Following the above logic, I spent several hours this week looking through the books of AIM listed Judges Scientific (NYSEARCA:JDG). The 63-employee company specialises in design, production and distribution of scientific instruments via its four subsidiary companies. These include:

·    Fire Testing Technology Ltd – one of the world’s major producers of instruments for testing of materials against fire (revenue up by 15% in 2008)

·    Aitchee Engineering Ltd (subsidiary of above FTT) – precision machining, fabrication, welding, engineering maintenance (revenue up by 14% in 2008)

·    PE. Fiberoptics Ltd – testing equipment for fiberoptics networks (revenue steady in 2008)

·    UHV Design Ltd – design of vacuum components (sales up by 29% in 2008)

·    Quorum Technologies Ltd – design and manufacture of instruments used in electron microscopy (acquired by Judges on 10th June 2009, for £1.5m)

The company’s capital is made up of £3.5m worth of debt (£814k of this being current) and £5.1m worth of equity. Debt to Capital ratio is hence 40.1%. The weighted average cost of capital is a low 7% (beta of 0.67, interest coverage of 5.3 gives a synthetic credit rating of A-). The company has access to an undrawn overdraft facility of £500k (as at 31st December 2008).
Judges grew its revenues at an average compound annual rate of 34% over the last four years to reach £4.5m for 1H2009 (£3.5m in 1H2008), ending the six-month period with a strong order book. Fibre Fire testing equipment clocked up 58% of total revenue, vacuum manipulation equipment contributed 27.3% and fiberoptic testing equipment brought in 14.5%. The diluted EPS for 1H2009 came in at 12.8 pence, an uplift of over 9% on 1H2008 (a £138k charge for amortisation of intangible assets relating to a new acquisition reduced net income). The management was thus able to deliver an adjusted 10.6% return on capital. Judges is clearly creating plenty of value.

Over on the balance sheet the total assets at end of 1H2009 were £12.5m (£8.7m at end of 1H2008). The increase is attributable to higher intangibles from Quorum acquisition, increase in receivables, inventories and cash. Cash and equivalents stood at £2.5m at end of 1H2009 (£1.6m at end of 1H2008). Total liabilities were £7.3m at end of 1H2009 (£4m at end of 1H2008). The increase in payables and debt were largely responsible. Liquidity was acceptable at Current Ratio of 1.52.

Cash from operating activities came in at £352k at end of 1H2009 (£996k at end of 1H2008), mainly as a result of foreign exchange gains and working capital movement. Cap-Ex for the period was £483k (Quorum acquisition net of cash acquired, plus property, plant and equipment). An interim dividend of 1.3 pence a share was declared (1.2 pence in first half of 2008), twelve times covered by earnings, scheduled to be paid out on 6th November 2009.   

Considering all of the above, the current share price, although at an all time high, does not appear to be reflecting Judges’ value fully. Given the beta of 0.56 and assuming a 5% annual dividend growth, the dividend discount model gives us an intrinsic company value well above £1.70 a share. Hence there could be tangible upside for a long term investor.

Factors playing in company’s favour include:

a) Buoyancy of high tech markets playing into UHV Design’s hands; directors believe there is scope to improve output through technical innovation and increased production capability,

b) Demand for higher bandwidth drives demand for fiberoptics testing gear; current world market worth around $600m,

c) Manufacture of solar cells will increasingly drive demand for vacuum components; current world market worth around $5bn (half of it being in Asia),

d) Management demonstrated good judgement when purchasing Quorum technologies by not paying through the nose; bought for £1.5m, annual sales around £4m, adjusted profit was £496K

e) Significant part of revenue is financed by government expenditure, affords protection in economic decline.

The two key concerns for potential investors include execution risk associated with acquisitions and currency fluctuations.