It is a distributor and relies on having the correct stock on the shelf and being able to lead the customer to the correct product.
FLO has put forward an acquisition story to the market predicated on the following;
- Being bigger will allow it to buy better therefore allowing margin growth.
- Being bigger will allow it to spread the cost of technical sales staff (the guys who can sell to a customer who doesn’t know whether they need an APR125 or an CDF 342). Whether its fluid power products as FLO does or electronics many customers will phone up and buy what they want. But for others you need the staff who can ask the right questions and guide the customer to an answer. This should drive both revenue up and costs down. You do not need an expert on the APR125 on each site just one you can get in touch with when needed.
- Being bigger will allow enough staff so it is genuinely technical in all the areas it needs to be across the group as a whole. Leading to higher sales.
- Being bigger allows the company to offer services others cannot. In particular it can keep service engineers fully busy. Smaller firms cannot. As service is a high margin business you improve both revenue and margin.
- Being bigger will allow synergies on stock. You will not need to hold a rare piece at every little location but just one in the country will be available to all. So stock levels can be reduced.
- Being bigger will allow better systems both operationally and IT and presumably allow higher quality staff, particularly in the back office.
- Being bigger you get better treatment from the delivery company. Cheaper prices but more crucially better service. This translates into happier customers and reduced costs sorting out late deliveries.
- Being bigger gets the name out and acts to help drive the brand and develop revenue
- Being bigger should give FLO a higher PE so it can buy at a 6 PE and instantly have that profit turned into its own 16 PE.
- Being bigger will bring in different revenue streams and reduce the reliance on the oil and gas industry.
In its latest RNS not only did FLO give no indication that it had achieved any of these synergies, it actually indicated that in certain key areas it was going backwards.
Specifically
- Margins are weakening
- Stock is high
- Staff costs are not being kept within expectations, let alone reducing.
I would also say that currently I am not convinced that the PE premium is being developed in the company’s acquisitions. Whilst we will need to wait for the full accounts for clarity the impression I have is many of the acquisitions are for a very full price.
Given this I have decided to reduce my target price by 5%, though I am still holding. However there is a limited margin of safety at these levels and further poor results would make this a sell.
Hopefully the full results will both give a fuller explanation of the position and some rays of sunshine. Distribution is a fundamentally simple business. You do not have to do much right to be successful and buy and build has worked well in many areas and fluid power would seem ripe. But when you only have to do a few things right differentiation is difficult and you cannot afford to do things wrong.
So holding with an eye to the sell side.