Focusrite has delivered 23% H119 earnings growth, despite market headwinds, reflecting continued market share gains for its Focusrite ranges, a strong performance in Europe and 260bp gross margin improvement. The company is actively seeking opportunities to use its substantial £26m net cash balance, as reflected in the current valuation.
Against a challenging macro backdrop and record prior year comparatives, Focusrite delivered a solid H119 performance. Revenue growth of 4.1% to £40.4m (slightly ahead of the £40m pre-close guidance) benefited from sterling weakness against the US dollar, while 0.5% constant currency growth contributed to an impressive two-year stacked growth rate of 26%. The 260bp increase in the gross margin to 44.3% helped to drive 11.4% EBITDA growth, while underlying PBT was up 22.6% to £7.2m. Net cash has increased by £3.4m from the year end to £26.2m.
Europe delivered robust sales growth of 21%, while in the US the company’s decision to pass on the 10% import tariff in October protected gross profit while North American revenue declined by 11%. Divisionally, continued strong demand for Clarett and Scarlett led to 12% growth in the Focusrite division, more than offsetting a 14% decline in the Novation division. This was driven by weaker demand for Launchpad, following several years of robust growth, and is being addressed with a pipeline of new products over the next 18 months.
We leave our FY19 and FY20 revenue forecasts broadly unchanged while cautiously assuming a further 50bp uplift to the FY19e gross margin to 43.2%. This is below the margin achieved in H1 as a further increase in US tariffs to 25% is still a possibility.
On a DCF basis, the share price is slightly ahead of our updated valuation of 471p (vs 457p), which assumes 10% revenue growth for five years beyond our forecast, fading to 2% in perpetuity, a terminal EBITDA margin of 21% and an 8.4% cost of capital. However, it does not reflect the potential return on investment of Focusrite’s excess cash. We calculate that the market is factoring in utilisation of excess cash at an attractive 12% post-tax ROCE.