# Surface Transforms’ Knowsley factory transformation is significant says Zeus

- Link: https://www.directorstalkinterviews.com/surface-transforms-knowsley-factory-transformation-is-significant-says-zeus/4121062434
- Published: 2022-04-27T08:16:07+01:00
- Author: Amilia Stone

**[Surface Transforms](https://www.directorstalkinterviews.com/company/surface-transforms-plc/sce.l)
plc** ([LON:SCE](https://www.directorstalkinterviews.com/company/surface-transforms-plc/sce.l))
has hosted a Capital Markets Day and site visit to its Knowsley, Merseyside, factory.
We last visited about a year ago and the transformation is significant. The factory
has been massively expanded and reorganised, with new equipment and processes configured
for high volume continuous carbon ceramic brake disc production. The Group has had
a highly successful few quarters, announcing a c.£100m contract with OEM 8, replacing
a previous agreement worth £27.5m. Also, a £45m award was announced in December,
with OEM 6. The total multi-year order bank now stands at c.£180m. Our estimates
show revenue rising from £2.4m just reported for 2021a to £38m in 2025e, and with
a pre-tax loss converting to £8.6m of PBT. Our assumptions include existing OEM 
contracts only – new wins and “carry-overs” are very likely. Costs are a concern
everywhere, we assume significantly higher opex, capex and working capital outflows
in 2022e to support more production volumes and offset inflationary pressures. But
from about mid-2023e we should see a sharp acceleration of profit and operating 
cash inflows, reflecting high operational gearing and reducing unit costs. As with
the scaling-up of any manufacturer there is execution risk, but the Group is well
on-track to becoming a volume supplier to the OEMs. Our DCF-based valuation is 110p,
indicating good potential upside.

**Key takeaways from the Capital Markets Day and factory site visit:**

**Factory expansion and new manufacturing strategy** – Over the past year Surface
Transforms has installed major equipment (e.g., furnaces and CNC machines) and restructured
factory processes with the aim of producing much higher volumes in a continuous (
versus batch) process. Already the lead time to produce a finished brake disc has
been reduced from nine months to one month. Through the remainder of this year, 
installation and commissioning of final equipment, and implementation of processes
to support continuous production, will be completed.

**Revenue opportunities** – In part, Surface Transforms is meeting existing demand–
from OEMs who have already adopted carbon ceramic technology for performance, weight,
and environmental reasons, and who wish to have dual supply. But also, the Group
is driving wider market adoption by providing a superior product and, ultimately,
targeting a lower pricing point. As we have discussed previously, we calculate the
current market size at c.£300m globally p.a. but potentially rising to multiple 
billions, with a focus on fitting carbon ceramic discs on higher priced vehicle 
models which have not yet converted from iron rotors.

**Cost pressures and margins** – We believe our assumptions on gross and net margins
are prudent and reflect potential cost pressures from accelerated hiring of employees
across the business, and higher materials and energy usage. Surface Transforms has
several cost efficiency plans in place which will help mitigate current pressures.
Margins should also naturally start to benefit from economies of scale, as production
ramps up.

**Refreshed Board **– Ian Cleminson (Executive Vice President and CFO of NASDAQ-
listed Innospec – IOSP) has just been appointed independent NED. The Group now has
three high profile, experienced, newish, or new NEDs: alongside the existing senior
team. Governance structures and experience levels are now more appropriate for the
next phase of growth.

**Zeus valuation** – We use DCF modelling to assess a valuation for Surface Transforms.
Our approach is prudent on input costs, working capital, capex requirements and 
the discount rate applied. Our valuation is 110p, approximately double the current
share price.

**Summary financials**

| Price | 53.5p | 
| Market Cap | £104m | 
| Shares in issue | 195m | 
| 12m Trading Range | 36p–77p | 
| Free float | 100% | 
| Next Event | Interims – September (est.) |

**Financial forecasts**

| Dec. y/e (£m) | 2021a | 2022e | 2023e | 2024e | 
| Revenue | 2.4 | 14 | 20 | 30 | 
| Adj. PBT | -4.4 | 0 | 1 | 5.9 | 
| EPS (p) dil. | -2.1 | 0.4 | 0.9 | 2.5 | 
| DPS (p) | – | – | – | – | 
| Net cash/(debt) | 11.2 | 0 | -1.5 | 3.2 | 
| P/E, x | -24.5 | – | 61.7 | 21.8 | 
| EV/Sales, x | 37.3 | 7.5 | 5.3 | 3.4 | 
| EV/EBITDA, x | -24.6 | – | 29.4 | 12 |

_Source: Company data, Zeus estimates_

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