Small cap companies listed on the JSE Alternative Exchange (AltX) Board are often overlooked by investors. It’s fair to say that investors take comfort from large cap stocks with high liquidity, history of growth and a certain amount of assurance around dividend payouts; however, it would be short-sighted not to consider a solid company with a competitive moat and high cash reserves.
Alaris is a leading global Radio Frequency (RF) company that has been listed on the JSE AltX since July 2008. The company designs, manufactures and supplies defence and specialised antennas. It consists of three subsidiaries: Alaris Antennas, COJOT, and mWave with more than 20 product lines and 1,600 products. This engineering business relies on its ability to design, spec and build specific products for its unique client base. Fully configured products, also known as mature products, are products that do not require any engineering design work, while newly developed products are either designed or customised by their engineers.
Army cars with jamming devices on the roofs (Source: Alaris)
The Alaris product range includes direction finding, high power transmit and monitoring equipment that is attached to army vehicles, drones, ships (including submarines) and army manpacks. A high power transmit device is used to prevent unauthorised communications from functioning, either by preventing communications entirely or by introducing spurious messages into the communications system.
Although Alaris started out as a consulting business mostly producing equipment that was specified by clients, management has worked hard to ensure development of IP (intellectual property) and securing repeat business. In the company’s Financial Year 2020 mature products, which are also considered easily repeatable sales, contributed c.85% towards revenue and newly developed products c.15%. This was closely aligned to management’s strategy of getting 80% repeat sales and 20% newly designed products.
Although predominantly South African based, Alaris generates 93% of its revenue offshore mostly in the USA and European markets. This niche player’s diversified customer base include the likes of Boeing, Airbus, NASA and SAAB, to name a few. Not only is the company unique in its product offering, but it attributes its continued success and competitive advantage to the large contingent of engineers, near inimitable IP and ongoing focus on staying ahead of the competition.
The company was unable to circumvent the negative impact that the global Covid pandemic and subsequent lockdown had on the supply chain and freight forwarding processes and could not ship to international customers, particularly during the 6 week hard lockdown in South Africa. But despite the work stoppage, the company’s resilient nature was reflected in the only slightly lower comparative revenue (R242.8 million in financial year (FY) 2020 versus R245.2 million in FY 2019). Further impacting profits, was negative impact on cost of sales by inflationary pressures in South Africa.
Notwithstanding these external events, Alaris managed to increase its cash reserves by 164% to R110.3 million, a position few large cap companies can claim to have achieved. With a market capitalisation of R258m the cash alone makes up almost 43% of the valuation of the company and management has indicated that it will be using the cash reserves for potential offshore acquisitions.
Antenna produced by Alaris (Source: Alaris)
The share price is currently trading at a price-to-earnings (P/E) ratio of 8.5x, which is significantly lower than its historic P/E ratio of 19.3x of 2016. It would be unfair to lump this one-of-a-kind company into the same category as other tech style companies on the JSE but it is apparent that at this level we would consider the share reasonably priced.
Alaris historic P/E ratio (Source: Cartesian Capital)
The Future of Alaris
To continue being successful, we believe Alaris needs access to a large pool of highly skilled engineers. When we asked them about this issue, we were comforted by the fact that they already have approximately 30 engineers in the business and have only lost less than a handful in recent years.
Due to the fact that 93% of the company’s revenue is generated offshore, this remains a good rand-hedge stock with the risk of rand appreciation negatively impacting the cost of certain raw materials offset by the sales in foreign currency.
Despite the large cash balance, we do not expect a dividend anytime soon, as the company’s CEO, Juergen Dresel, has indicated that they are looking to use their cash pile for international acquisitions and are specifically looking towards their biggest market, the USA. In discussion with the CFO, Elsie Muller, it is apparent that they are acutely mindful of not overpaying for any future purchases.
We believe this is a well-run company, with a deep competitive moat and a promising future.