Companies: DLC ��

Delcam innovates in the computer-aided design/computer-aided manufacturing (CAD/CAM) technology field, developing and providing specialist software used for the design, manufacture and inspection of complex shapes and tooling. CAD/CAM has been used to great effect within the manufacturing industry for many years. It saves users time and money and brings improvements in product consistency and quality.

Quoted on AIM, profitable, highly cash generative and boasting a formidable five-year trading track record, the group has undoubted organic and acquisitive growth prospects yet trades on lowly multiples for both this year and next despite a strong share price performance.

Further spice has been added by a �6.1 million investment into the business by engineer and close collaborator Renishaw, a constituent of the FTSE 250, which should boost business at the Birmingham-based group. ‘We have customers in common,’ enthuses finance director Kulwant Singh, ‘and the investment develops our commercial relationship with Renishaw and provides us with money for further acquisitions.’

Strategy

Guided by Singh and managing director Hugh Humphreys, Delcam has grown steadily since its formation in 1977, burgeoning into the biggest developer of product design and manufacturing software in the UK.

It may be Midlands based, but the business boasts a global sales network and presence in 65 countries, as well as a host of blue-chip names on its client roster – BMW, Nike, Boeing and Nissan among them. In all, it has 15,000 organisations using its wares.

Automotive and tool making have been the group’s traditional domain, although Delcam has a presence in sectors such as footwear and aerospace as well as consumer products and packaging and even the emerging area of dentistry, where the technology helps dentists create precise shapes and sizes for crowns and bridges.

While strong in Europe and the Far East, a core strategic goal for Delcam has been to build a stronger presence in the USA.

In some respects this has been achieved. In 2005 it acquired CAM software specialist Engineering Geometry Systems, a deal that brought the FeatureCAM product under the group’s control and consolidated its position as the number one global supplier of specialist machining software.

In July last year, the acquisition of another US concern, the highly profitable IMCS, brought the PartMaker CAM suite to the fold.

‘The only immediate difference existing FeatureCAM users will see,’ said Humphreys at the time of the deal, ‘is a change in the company name to Delcam USA.’ Interestingly, his efforts have been focused on expanding FeatureCAM’s sales outside the US, especially in Asia, and a similar strategic push is under way with PartMaker, a product with only limited non-US sales at present.

A more recent domestic addition is Crispin Systems, a UK concern giving the group an unrivalled CAD/CAM software offering for the footwear industry. Crispin, bought for an initial �500,000 with a performance-linked earn-out, is a key supplier of CAD/CAM systems to a massive global industry which made more than 11 billion pairs of footwear in 2005.

Crispin’s software provides more than 2,000 customers including Nike and Dr Martens with greater flexibility and accuracy in the design process, enabling lower-cost manufacturing. In the wake of the deal, Delcam’s footwear software operation became the biggest supplier of specialist software to the industry.

Diversification – reducing dependence on the mould and die industry – is another strategic goal, with Delcam having progressed its software sales in the aerospace industry and having had early success in the dental industry with its Dentmill product.

Alongside all of this, management is keen to grow the proportion of highly visible, high-margin maintenance revenues. Last year, maintenance revenues edged ahead by ten per cent to �7.1 million and now make up 27 per cent of sales.

Maintenance earnings underpin City forecasts and hefty spend on research and development (R&D), a necessary evil given the need to ensure products retain their edge. Delcam has recently released improved versions of all its main software products.

Management

One of the group’s founder directors, managing director Hugh Humphreys, is a trained aircraft engineer who worked at British Aerospace for ten years while studying for a Masters degree in production management. He subsequently joined the Delta Group in the 1970s. In 1989, Delcam was bought from Delta Group in a management buy-out led by Humphreys, who then managed the flotation of the business onto AIM in 1997. As well as leading from the front, Humphreys spends part of his time developing the Russian market for the group’s products.

Keeping a keen eye on costs and acquisition synergies is Humphreys’ right-hand man Kulwant Singh, an experienced accountant who qualified with Price Waterhouse and earned his spurs through a stint with Haines Watts. Singh joined Delcam in the early 1990s as the financial controller and today bears responsibility for all financial aspects of the group.

Non-executive chairman Thomas Kinsey, a fellow of the Royal Academy of Engineering, joined the company as chairman at the time of its buy-out. Well versed in the workings of the manufacturing industry, he was previously joint managing director of Delta and deputy chief executive of Mitchell Cotts and has served on the council of PERA and Cranfield Product Engineering Centre.

A further key figure is co-founder and technical director Edward Lambourne. A chartered engineer and another crucial player in the 1989 buy-out, Lambourne joined Delta in the early 1970s and was responsible for the first introduction of CAD/CAM software. He currently has responsibility for the group’s development and IT system activities and oversees one of the UK’s biggest mechanical CAD/CAM development teams.

Prospects

An examination of financials for the last five years suggests prospects are robust. Delcam delivered record sales and profits for 2006 despite the considerable headwind of dollar weakness. Humphreys explained that the results reflected ‘the strength of our offering and our reputation’.

Sales rose 14 per cent to �26.7 million last year and pre-tax profits (before goodwill and exceptional items) grew to �2.8 million (�2.5 million) on healthy operating margins of 10.4 per cent. Good software licence sales combined with acquisitions and a full-year flourish from FeatureCAM in particular drove the financials while Singh unveiled a healthy net cash inflow of �2.5 million from the group’s operations. Profits met numbers in the market although the ambitious Singh conceded that profitability was constrained by R&D investment and he says ‘we want to be more aggressive in terms of the bottom line’ from now on. Dividends were raised by 11 per cent to 5p, covered more than six times by a rise in earnings from 32.3p to 33.5p.

A key tick in the prospects box is a placing of 1.5 million new shares at 400p with Renishaw. This placing will help fund expansion and investment in product development as well as sales and support.

These two businesses have worked together for many years, share common customers and complement one another in the inspection market. Renishaw produces inspection hardware while Delcam provides inspection software and the investment represents a ringing endorsement of Delcam’s software offering and R&D expertise. Closer co-operation should enhance sales for both businesses, with management having identified opportunities for developing software supporting Renishaw products. Priced at 400p, the investment also underpins Delcam’s valuation.

Valuation

Considering the company’s highly cash-generative qualities and the fact that the group has now scored profitable growth in 18 out of the last 19 years, the shares are still lowly rated by the market.

For 2007, Brewin Dolphin analyst Michael Vassallo is looking for normalised profits growth to �2.9 million on an improved top line of �29.5 million. Earnings are forecast to ease marginally from 33.4p to 33.3p, reflecting the effect of the placing and a loftier expected tax rate. Despite these earnings-constraining factors and a good recent performance from the shares, Delcam trades on a forward multiple of 12.5, a substantial discount to the prevailing software sector average of 28 times. Furthermore, with the placing having given a boon to cash balances, this year’s dividend estimate has increased to 5.4p (5p).

For 2008, sales (excluding future M&A activity) are conservatively forecast to approach �31 million from which pre-tax profits of �3.2 million and earnings of 34.3p could be delivered. Again, on these numbers an undemanding forward p/e of 12.2 – and a market cap of just over one times forecast sales – should alert value investors.