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

Ceramic Brakes

Surface Transforms plc (LON:SCE) makes advanced carbon ceramic brake discs for high performance cars. The discs offer significant weight, performance, durability and environmental benefits over conventional iron products; they are also becoming a crucial component in the development of EVs. Although more expensive to buy, the total lifetime cost can be competitive due to reduced wear and tear. Unusually for the automotive sector, there is only one main supplier of these discs, Brembo SGL. The Group, following years of investment, now offers a credible alternative for OEMs. Despite COVID-19 headwinds, recent news has been positive, including significant contract wins and the expansion of manufacturing capacity. The Group also recently completed an oversubscribed placing to improve its finances. The next 12-18 months will be tough for all suppliers to the automotive sector, but the Group has innovative and competitively priced products and a well invested manufacturing platform. The market opportunity is also very large, with current low levels of adoption for these discs. Our analysis of earnings sensitivity indicates significant potential upside. Customers are backing this team, and the dual-sourcing proposition, with new contracts. Surface Transforms is on-track to becoming a volume supplier to the OEMs.

We initiate coverage following recent positive news – COVID-19 is having a major impact on demand for vehicles globally. Surface Transforms is not immune, and as part of a recent fund raising, management stress-tested its contract pipeline and finances, and implemented cost reductions. Guidance for revenue in 2020e was halved. That said, the business is fully operational, no contracts have been cancelled and new business development is progressing. In a further trading update, the Group reported that with strong sales and constructive customer discussions, it remains on-track to reach positive adjusted EBITDA in 2021e. Management expect to make further contract announcements during 2020e. Interims are due in late-September.

Growing the market and challenging a near-monopoly supplier – Due to their cost, carbon ceramic discs are currently only fitted to expensive cars. We estimate the current market size globally is around £250m. The Group, with under £2m of sales currently, has a tiny share. The aim is to grow the market and promote much wider adoption of this superior technology by driving down the cost of discs. This is potentially a multi-billion-pound market. The Group is also challenging a dominant incumbent in Brembo SGL. OEMs want dual-sourcing and, to address this, Surface Transforms has built an independent and resilient supply chain.

Unlocking significant medium-term value – The next 12-18 months will present further challenges for all suppliers to the sector due to the weak demand environment. Surface Transforms offers competitively priced products, and contracts are flowing. This is now a well invested platform and operational gearing is high, as we show in our analysis of earnings sensitivity. Progress is being made on a potentially significant opportunity with German OEM 3. We think automaker supply chain resilience, requiring dual-sourcing, will become even more important for OEMs in the post COVID-19 world. Looking further out, carbon ceramic discs are particularly well suited to EVs. Our DCF-based methodology indicates a valuation of 40p per share. Surface Transforms is well positioned to deliver for the medium-term

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Surface Transforms plc

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Surface Transforms plc

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