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Ceramic Brakes

Surface Transforms “well positioned to deliver for the medium-term” says Zeus Capital

Surface Transforms plc (LON:SCE) has announced a major contract win with a manufacturer of EVs. Lifetime revenue is estimated to be £27.5m. Our 2021e revenue forecast is lifted by c.80% and 2022e by c.120%. The improved OEM order book brings better visibility and stability to revenues. To fulfil the order, significant investments will be made in headcount, but the Group should now report a net profit in 2021e against our previous forecast for a loss. Additional working capital and capex are also required but the cash position should improve materially in time. The award demonstrates the performance, weight and environmental benefits of carbon ceramic discs when fitted to EVs. More orders from this customer and others should flow. We showed in our recent initiation note, Release the brakes, 19 August 2020, that the market opportunity for carbon ceramic discs is large, irrespective of whether for ICEs, EVs or hybrids. The Group is on-track to becoming a volume supplier to the industry. With increased estimates our valuation is lifted to 45p from 40p.

  • What’s new? – The Group has been selected as a sole supplier of a carbon ceramic brake disc on a new EV by a manufacturer named as OEM 8. As usual for the autos industry, volumes are not guaranteed but OEM 8 is growing strongly, and the assumptions underpinning guidance from management appear prudent to us. This award should significantly lift revenues from 2021e, and profitability is predicted in 2021e against 2022e, previously. The customer base is also now more diversified. Alongside this contract, the Group has issued a positive trading update, guiding to higher revenues for this year.
  • Our forecast changes – Revenue is increased in all years, profits come sooner. For 2020e, with more orders from Near OEM and retrofit customers, £400k is added to sales guidance, to achieve £2m in total. In later years, we have added £27.5m for OEM 8, phased to 2024e as guided by management. That said, we are slightly more cautious on OEM 6 and other revenues. Net, we lift revenue for 2020e-2022e by c.£10.5m. To fulfil the OEM 8 order, costs will rise in the near term, including employee, insurance and depreciation expenses. That said, as mentioned, profitability is achieved more quickly. Cash will also be impacted near term, reflecting these higher set-up costs, and capex. But once large deliveries start to flow in 2022e, the cash position improves. We assume, conservatively, a c.60% increase in gross cash to c.£3.5m from c.£2.3m by end-2022e. Further contract wins will likely require less up-front investment and incremental margins on new activity should be higher.
  • Unlocking significant medium-term value – Surface Transforms offers competitively priced products and contracts are clearly flowing. OEM 8 is a key award, but the Group also remains in discussions with other automakers, including German OEM 3. Generally, we think auto parts supply chain resilience, requiring the dual-sourcing which the Group offers, will become even more important for OEMs in the post COVID-19 world. Our DCF-based method indicates a valuation of 45p from 40p per share, lifted with higher estimates. The Group is well positioned to deliver for the medium-term.

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