Investing at the speed of light

Gooch & Housego almost got away.

I first looked at Gooch & Housego (GHH) last March, in the depths of the financial crisis. The shares looked cheap but the company, which makes components for industrial lasers, was in a crisis of its own. It had taken on dollar denominated debt to buy General Optics (now Gooch & Housego (California) LLC), the pound had plummeted against the dollar increasing the debt in sterling terms, sales and profitability were falling, and Gooch and Housego, which had relatively little debt in its previous financial year was renegotiating its banking agreements with RBS (also in crisis) and delaying the publication of its annual report for 2008.

The shares didn’t seem to fit the safety first remit of the Thrifty 30 model portfolio, and although Gooch & Housego secured a new banking facility, the resignation of its chief financial officer a week later offered little in the way of reassurance. I made a note to look at its interim results, to assess its indebtedness, but forgot. Naturally, the shares galloped to a fourfold profit for any investor who bought them last March.

A year on, the situation doesn’t look so desperate.

Gooch & Housego recently published its annual report for 2009. Ignoring exceptional items, restructuring and refinancing costs and the amortisation of intangible assets, the chart shows that, temporarily at least, the company’s back where it was in 2000 in terms of profit and financial strength.

That’s not such a bad place. It’s profitable, and less than half of its funding comes from debt of one kind of another. Shareholders own 56% of the assets. In the interim period, albeit in what now looks like a go-go global economy, it showed it can earn higher profits and repay debt, raising shareholders’ equity from about £10m to £31m.

Whether it profits in future depends on its strategy, which in the short-term has been to cut costs by reducing staff numbers, and the hours they work, and scrap the dividend, while maintaining research and development expenditure.

Judging by its annual reports and acquisitions, longer term Gooch & Housego is diversifying into new products, markets and regions. With £22m of sales made in North America, its by far its biggest market, Europe is second (£6m) the rest of the world third (£5m) and the UK fourth (£4m).

Its most famous products are its Q-Switches, which make industrial and medical lasers much more powerful, but it’s ambitions are increasingly in the life sciences and defence markets and in the manufacture of whole systems as well as components.

The cost of diversification is the reason why investors and staff were smarting so severely last year. Gooch & Housego bought General Optics to become a supplier to the US defence and aeronautics industries, but along with the recession, it precipitated the crisis in shareholder confidence last year. The cost of research and development is one of the reasons investors weren’t paid a dividend, yet its too early to say whether products like its hyperspectral imaging instrument (thank goodness for Wikipedia), three years in development, was worth the investment. The company has sold some for trials, but components and materials account for over 90% of sales, while instrumentation and life sciences bring in less than 10%.

Nevertheless, the company’s history goes back to the Second World War, when its founders were evacuated to Somerset and subsequently set up a glass processing business. Despite the dramatic recovery in its share price, the shares cost only eleven times average earnings over the last ten years, just outside bargain territory, and, especially as management describes a ‘steady recovery’ in demand, its F_Score of 6 suggests it has the financial strength to prevail.

Last month, Paul Heal, a non executive director who recently served as interim finance director bought 10,000 shares at 167.5p, which could be construed as a vote of confidence in both the books and his successor, Gooch & Housego insider Andrew Boteler.

I thought I would end up rejecting Gooch & Housego, but I must admit I’m tempted to add it to the Thrifty 30. The only thing holding me back is the slew of company results due, for those companies with years ending in December 2009. With the portfolio becoming a bit full, I’m worried I might miss out on an obvious bargain, so I’m going to put it on hold, again.

Let’s hope the price doesn’t run away this time.

Thrifty 30 updates:

The current Thrifty 30 portfolio

Holders Technology reported a small full-year loss, increased cash balances, and the acquisition of an LED distributor.