How to profit from tougher electrical standards

Sep 05, 2008

Above my desk I have a small lamp plugged into the mains via a power adaptor. I have noticed that the latter gets extraordinarily hot considering that it is powering such a small device. Unfortunately this means that much of the electric power that I am paying for is being dissipated in the form of heat and not light.

With the cost of electricity being what it is, we could all do with using less. This has presented an opportunity to a small company that has an admirable record of growth, not least in terms of a rising annual dividend payment, but somehow has never quite captured the stock market's imagination.

Despite reporting a 13% rise in interim profits last week, and a further increase in the dividend, the shares of Stadium Group (LSE: ASDM) trade at just seven times earnings, and yield almost 7%. With virtually no net debt on its balance sheet, Stadium is hardly in the emergency ward, and this looks like yet another example of the stock market simply mispricing a small company. In truth though, despite its worthy history, Stadium has never managed to tickle the imagination of investors. That is probably because, as a diversified manufacturer of fairly basic electrical and plastic products, it is doing the sort of things that UK companies are not supposed to be very good at.

Making use of low cost Chinese manufacturing

Faced with the relatively high cost of making things in the UK, some manufacturers have pursued a strategy of making 'niche' high-value-added products. Others have decided to source from third parties overseas. Stadium has done both, but with a difference. Rather than use third-party manufacturing contractors overseas it has, since 2000, had its own factory in China.

Thanks to this, it is able to offer access through a UK company to low cost Chinese manufacturing. For the Chinese, one of whom, Ken Leung, is on Stadium's board, the arrangement brings in work while avoiding the need to engage directly with foreign customers, something that many Chinese still find awkward.

Stadium offers a complete service, from design through manufacturing, testing and worldwide shipping and the Dong Guan factory principally serves Stadium's largest division, electronics. Of the first, the largest customer is SSL for which Stadium manufactures its Durex 'play' range – 'tasteful, discreet and ultimately very effective', so I understand – while another important customer is Hozelock, for which Stadium manufactures electronic water controllers.

Stadium has a particular specialisation in ventilation, making electronic controls and meters for XpelAir, Vent Axia and the Swiss giant Landis & Gyr. But, illustrating one reason why not all manufacturing can be shifted off-shore, the tendency for architects to leave the specification of customised building controls until the last minute has meant that Stadium has maintained a manufacturing facility in Hartlepool that generates about 20% of the division's sales.

The turnover of the plastics division is about £11m and the largest customer here is Mothercare – mainly 'bath time and toilet training', according to chief executive Nigel Rogers, but half of the division's turnover is for building products. The Stadium name is well known for injection-moulded plastic products, such as ventilators and builders' buckets. These are supplied to all the major builders' merchants from a factory in Walthamstow. In this division, Stadium has felt the impact of rising plastic and energy prices, and, strategically, this division is not a priority. However, because the division's income is effectively tax-free to Stadium, but would be taxable in any other hands, it has been unable to conclude a sale.

Two divisions favoured for expansion

It is the electronics and power divisions that are favoured for expansion. The latter has developed its own IP and sells power supplies, convertors, invertors and battery chargers. Manufacturing is done either in China or in Peterborough; design at Diss in Norfolk. Distribution and sales are handled by the Newbury office, an arrangement that reflects the recent acquisitions of distributor KRP Power Source and a competitor, Ferrus Power. The division is about to launch its own range of standard products, and Rogers sees growing demand based on the increasing stress upon energy efficient products. While a cheap power convertor costs only a few pounds, a more expensive one will waste less electricity through all that excess heat and will ultimately save money. This trend will only be encouraged by minimum energy and efficiency standards, already introduced in the USA and now bound for Europe.

So although Stadium has suffered from higher input prices and is probably seeing some slackening of demand from the building industry, it is still comfortably profitable and sufficiently confident to have raised the interim dividend. An old rule of investment is to buy shares when the dividend yield exceeds the PE ratio. That is all but the case with Stadium. I'm watching this one closely. 

• This article is taken from Tom Bulford's free daily email, Penny Sleuth .

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