This is an excerpt from Forager Funds June 2016 Quarterly Report
If you have recently visited Bondi Beach, this won’t come as a surprise: tattoo removal is a growth industry. It’s an important trend for one of the International Shares Fund’s largest investments.
In early January the Fund purchased shares in El.En. (BIT: ELN), a manufacturer of medical and industrial lasers based in Florence.
The medical division accounts for 70% of El.En.’s sales and almost all of its profits. Products span machines used for the removal of hair and tattoos to more complex devices used for the treatment of conditions such as kidney stones and vaginal atrophy. The remainder of the business — its industrial division — focuses on lasers used to cut wood, metals and glass during manufacturing processes.
Aging and more health-conscious populations mean that the medical market for lasers should continue to grow — industry expectations are for the market to be worth in excess of $4bn by 2020 compared to $2.2bn today.
El.En.’s share of this is roughly 7% and company-wide sales have grown from €25m in 2000 to €220m in 2015, mainly thanks to strong demand for its medical lasers.
While competition is quick to copy the company hit products, El.En., which was founded in 1981 by a university professor and one of his students, has a strong history of innovation as demonstrated by its ability to roll out new and successful products year after year.
Profits have been mostly reinvested in expanding the business distribution network across the world and acquiring smaller businesses with great products that lacked the scale to compete on a global stage. However, the company has also been able to pay dividends to shareholders.
Its balance sheet looks great too. At the end of the 2015 year, the company had around €60m in cash and only €20m of debt. Despite this cash balance, the company’s return on capital has been robust.
Insiders have a lot of skin in the game, owning more than 50% of the company. And we have been impressed with their focus on capital allocation and long-term decision-making.
At the time Forager purchased its shares El.En. had a market capitalisation of €185m, traded on a price to earnings ratio of 15 times and sported a dividend yield of about 3%.
On top of a growing business and a bullet-proof balance sheet, El.En. also owned a 4.5% stake in Cynosure(NASDAQ:CYNO), a leading American company in the medical laser industry (and a former subsidiary of El.En.). While contributing little to the company’s profitability, this investment was then worth €37 million.
After adjusting for the value of this investment the company was actually trading on a price to earnings ratio of only 12. This looked extremely attractive, not only because of the quality of the business and the growth to come, but also because the company‘s main competitors, most of them still unprofitable, were trading at much higher valuations (see table below).
Since the Fund’s investment, Mr Market seems to have regained his senses and El.En.’s share price has increased nearly 40%. We are not sellers yet, because we have been more than happy with the company’s progress.
Medical lasers are continuing to sell well and the company’s industrial products are starting to contribute to profitability too. The company recently sold its investment in Cynosure and plans to reinvest part of the proceeds in expanding its distribution network.
El.En. should be able to generate in excess of €230m in revenue in 2016 and €15m in net profit, excluding a gain on the sale of Cynosure shares. Adjusting for the excess cash in the business, it still only trades on a multiple of 13 times this year’s expected earnings.
At a recent meeting with management, the CEO expressed some dismay at the valuation gap between his stock and US-listed peers. So much so that he suggested the board would consider a US listing for the company.
Were that to happen, we would expect the stock to trade meaningfully higher. If it doesn’t, we’re more than happy to own a growing, dividend paying business an attractive price.