The right setting for Ring

SHAREHOLDERS in the fast-expanding Graystone engineering group have needed deep pockets in recent years to help fund a string of equity- financed acquisitions. But the chairman, Dick Richardson, insists that the latest chunky rights issue will be the last for a long time.

That leaves the shares looking cheap at 12p. Profits should climb strongly over the next couple of years to drop price-earnings ratio well into single figures, and the yield on the forecast dividend for the year ending this month is 5.4 per cent. The price could double in two years.

Rights issues are often buying opportunities, because the need to absorb a tranche of new shares temporarily depresses the price. In the case of Graystone, the depressant effect may have been working for some while, because the existing shareholders, a who's who of big institutions, have been expecting one last big equity-funded deal, removing their incentive to bid up the price of the existing stock. Unusually, buyers of the new shares will qualify for the final dividend of 0.34p, reinforcing the yield attractions of the shares.

The group has been assembled through a series of deals which have taken turnover from an annualised pounds 3.3m in June 1992, when Mr Richardson arrived as chairman and chief executive, to close to pounds l00m following the latest deal.

Landmark transactions included buying component engineering businesses from Prospect Industries in October 1992, the April 1993 acquisition of Cableform from FKI for pounds 8m, the takeover of British Syphon Industries for pounds 32.9m in November 1993, and the latest deal to buy Ring Group, a distributor of automotive and electrical products with turnover around pounds 40m, for a maximum pounds 12m.

Mr Richardson claims this blitzkrieg of activity has given him the critical mass to achieve solid organic growth over the next five years. His initial objective for Graystone was to build a group with sales of pounds 100m, profit margins of 10 per cent and a 5 per cent yield. The latter has been achieved: the turnover target should be met in 1995-96, although margins for the enlarged business will be pulled down by Ring, at least temporarily. Based on pounds 55m of turnover excluding Ring, and forecast profits of pounds 5.8m for the year to June 1995, the 10 per cent target has been also hit.

Encouragingly for new shareholders, Mr Richardson's revised objective is pounds 200m sales in five years, which he believes can be achieved without further large acquisitions - not that I expect him to go that long without another big deal.

The Ring deal looks a good one both in its own right and as an excellent fit with Graystone's existing automotive parts distribution. Graystone is paying an initial pounds 9m for a business that made operating profits of pounds 2.4m in the year to June 1994. Profits will be lower in 1994-95 because of an extensive reorganisation of the business, which has involved considerable duplication of costs. But they could easily revive strongly in 1995-96, as implied by the pounds 3m deferred element in the consideration.

Up to an additional pounds 2m is payable, based on a formula of five times any operating profits above pounds l.75m. Up to a further pounds 1m is payable on a pound-for-pound basis on any cash generation above pounds 2.4m. Payment of the full deferred element, by no means impossible, says Mr Richardson, would require Ring to make operating profits of pounds 3.4m. That would give a terrific lift to Graystone's profits and share price.

One reason why Ring should fit well into Graystone is the scope for cross- selling to differing customer lists. Both supply branded and own-label products for the automotive and lighting industries. Ring supplies big chains, Graystone supplies smaller independents, partly through a fleet of owner-operated vans. The plan over the next two or three years is to bring Ring's operating margins of around 6 per cent up towards the 8.8 per cent achieved by Graystone.

The greatly increased scale of the group's distribution business should also benefit Graystone's manufacturing divisions in electrical and mechanical engineering. The group is strongly placed in a number of niche markets, including rotary tables and industrial cooling equipment, photo-electric cells, interior and exterior lighting for the rail industry, and low-voltage lights for the caravan industry. Margins on these activities are typically much higher than on distribution and the group is steadily building exports.

Next year's profits should also benefit from smaller in-fill acquisitions made over the past 12 months. Analysts were forecasting group profits of pounds 7m for 1995-96 before the Ring buy.