El.En. is an Italian company that manufactures and sells laser systems in the medical and industrial sectors. As the graph below illustrates, its products are highly appreciated worldwide: most of El.En.’s revenue is made outside of Italy (78%), and as much as 65% outside Europe. It controls a group of companies it has either created or acquired over the years.
The company was founded by Leonardo Masotti, a university professor of electronic engineering, and one of his best students, Gabriele Clementi. El.En. was listed on the Italian stock exchange on the index Ftse Italia STAR, which is reserved for stocks with high requirements (1). Cynosure, an important El.En’s subsidiary, was listed on the Nasdaq stock market in 2005 and sold for €23 million in 2016.
As we can see in the charts below, the medical sector is the most relevant based on revenue. In the September 2017 quarterly financial report, the company communicated that the industrial sector had a growth rate of about 52% in the first nine months of the year, well above that of the medical sector (about 5%).
In the graph below we can see that the most profitable sector is medical, with a gross margin of about 50% in 2016, whereas the industrial sector gross margin was much lower (about 30%).
So, the less profitable sector is growing much more than the most profitable one. If this trend continues into the future, there will be a deterioration of the profitability margins and, consequently, the company’s shares could become a bit less attractive for potential investors despite the overall high growth rates of sales and operative income.
Compared to 2016, EBIT margin declined in the first nine months of 2017 but increased in the third quarter. Why?
Two factors influenced the company’s EBIT margin (and therefore its profitability) during 2017:
- The increase of the weight of industrial sector revenue, which was less profitable than medical sector revenue, on the total revenue;
- The reduction (and hence, improvement) of the operating leverage, caused by a change in the costs structure, with an increase in the weight of variable costs on total costs. A lower operating leverage means a lower risk for the company’s operations because there is a reduction of the sensibility of EBIT with respect to a change of the company’s revenue.
If we consider the third quarter of 2017, the effect of the improvement of the operating leverage on EBIT margin more than compensated for the worsening of the sales mix caused by the higher growth rate of the industrial sector compared to the medical sector. If we consider the first nine months of the year, we can see that the reduction of the operating leverage was not able to compensate for the worsening of the sales mix. This led to a decline of the EBIT margin.
El.En. Revenue, EBIT and Net Income
In light of 2017 revenue so far, El.En. will probably hit a new revenue record at the end of the year. The same will probably happen for EBIT, but not for net income. In fact, in 2016, El.En. benefited from a capital gain of €23 million resulting from the divestment of an important subsidiary, Cynosure, that increased net income to a level way higher than previous years. That said, the best indicator for monitoring the company’s performance progress over recent years is not net income, but EBIT (or alternatively, adjusted net income).
From the graph below we can see how El.En. was affected by the recession triggered by the sub-prime crisis in 2007; it was able to slowly but consistently recover, exceeding 2008 EBIT levels only in 2015, and improving it in 2016 with the historical high.
Negative effects of a strong euro
As I wrote before, 65% of El.En. sales are made outside Europe, and this highly exposes the company to exchange-rate risk; a strong euro represents a big problem.
As we can see in the graph below, in the last few months, the euro has appreciated against the U.S. dollar despite the European Central Bank’s quantitative easing designed to increase inflation. This monetary policy should have, theoretically, decreased the value of euro.
A strong exchange-rate penalizes exporting companies that manufacture high-quality products required worldwide.
In summary, a strong euro has a negative impact on El.En. operations in two ways:
- it hinders its exports;
- it favors competitors with a cost base in dollars.
El. En.’s stock price
As we can see in the chart below, El.En.’s stock price has grown a lot in the last two years (about 160%). In order to get an idea of how much it has increased with respect to its peers, we can compare it to the index Ftse Italia Mid Cap, which has only gone up by 23% in the same period.
Thanks to its performance in recent years, El.En. has managed to become a beautiful reality of the Italian stock market. The quality of the products, the constant research and innovation through investments in R&D, and the propensity to export make El.En. a world-class company.
In the long term, El.En. will benefit from the increase in life expectancy and the subsequent grow of the demand for aesthetic and medical treatment that require laser systems.
As for the industrial sector, the higher growth rate compared to estimations is the result of increasingly obsolete high-powered CO2 laser sources being replaced by fiber laser sources in the manufacturing sector.
El.En. is thus active in two fields with different features that, when combined, represent a good mix of high growth (industrial sector) and high margins (medical sector). Now, it is essential for management to increase the profitability margins of the industrial sector as much as possible in order to equal those of the medical one, maintaining the company’s high overall profitability margins.
What do you think about this company? Would you invest in it?
Let me know in the comment section below.
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1. El.En. About El.En. group. http://elengroup.com. [Online] http://elengroup.com/group/about-elengroup.html.