Incap
I have two reasons to write:
1.to provide a foundation for readers to conduct their own research by outlining the current situation of the company. By doing this, I hope to help readers form their own assumptions about its future.
2. to revisit these assumptions in a few years to see how accurate (or wildly off) they were, allowing me to reflect and hopefully refine my thought process in the process.
Not an investment advice. duh
Content:
Equity story
Revenue growth drivers
Profitability drivers
Cash Flow drivers
Scenario to returns
Equity Story
Incap has been on a roller coaster over the past five years. From 2019 to 2022, the company saw rapid growth, largely fueled by increased orders from its largest customer. However, in 2023, the situation shifted dramatically when this customer initiated a massive destocking effort, leading to a 41% drop in sales from them. As a result, the group's overall revenue declined by 17%.
This decline was partially offset by two factors: the acquisition of Pennatronics in the US and 17% organic growth from other customers. Over this five-year period, Incap has reduced its reliance on its largest customer. This shift is due to organic growth from other customers and two acquisitions: AWS in the UK (2020) and Pennatronics in the US (2023).
The share of revenue from Incap’s largest customer has fallen significantly, dropping from a peak of 67% in 2022 to an estimated 40% in 2024.
LTM
While Incap experienced tremendous revenue and profit growth between 2019 and 2022, its cash flows were strained due to a buildup of inventory. During the "shortage" crisis brought on by the COVID-19 pandemic, the company had to stockpile excess inventory to ensure it could meet future delivery demands.
This situation shifted in 2023 as supply chain availability improved, and a destocking phase began. As a result, working capital was freed up, leading to an improvement in free cash flow.
Revenue growth drivers
1. Largest customer’s orders will likely increase in 2025
At the start of 2024, Incap announced that orders would increase quarter by quarter, and that’s exactly what happened. The company’s stock rose by 38% during the year, reflecting a positive outlook and reduced uncertainty about its largest customer’s order activity.
As shown in the chart below, orders from the largest customer have been steadily increasing. I expect this trend to continue gradually in 2025 (all figures are my own estimates and almost certainly somewhat inaccurate). While the largest customer was something of a challenge for investors last year, this year, it is likely one driver of revenue growth starting in 2025.
Incap does not expect order levels to return to their 2022 peak in the near future, but over the longer term, this could happen as the customer continues to grow.
2. Acquisitions
Incap has made a succesful acquisition in July 2023, when they acquired Pennatronics. Incap has communicated that Pennatronics has developed better than expected since the acquisition. This a rare treat and gives confidence that the uncertainty round this acquisition can be left behind. Incap has also communicated that the company is now seen truly global, which I believe will drive organic growth in 2025 and beyond.
Incap has been clear that their primary objective is to find and do acquisitions and with two solid acquisition made in 2020 and 2023, I take this as positive. Incap is strict when it comes to doing acquisitions and I believe thay can find good targets with correct cultural match.
Incap financial health is tuned to acquisitions. Incap currently has a net cash position of EUR 10.4 million and their future capital needs are low. Incap’s operating model is asset and CapEx light and in addition to that their working capital needs are easing. Incap doesn’t need to build up inventory, because their customer order visibility is worsening. So while this is a ‘lower multiple accepting’ factor as it comes with more uncertainty it simultaneously allows for better cash flow conversion in the future.
Incap’s covenants are tied to Interest-bearing debt to EBITDA level of 3.0 which was 1.1 in Q3 2023. Hence, Incap has ample capacity to do more acquisitions.
3. Market growth fuels organic growth
Organic growth from other than the largest customer. Incap has proven itself this year as the organic growth from other than the largest customer is flattish this year, while other EMS companies revenues are declining double-digits organically. This gives me confidence that Incap’s low-hierarchy and flexible organization is able to execute above the market and can at least continue to growth along the market growth.
Summary - revenue growth drivers
I look at the revenue growth from three perspectives: growth from the largest customer, organic growth excl. the largest customer and acquistions.
In summary, I believe the largest customer will modestly continue to grow from the 2024E level. I have input 8% growth from the largest customer in 2025, reaching the same level as in 2023.
I have input 10% growth from Pennatronics in 2025E reflecting the fact that Incap has stated it’s goes better than expected and synergies in sales from that acquisition.
I estimate that the organic growth excl. the largest customer is 10% in 2025, which is above the market growth. I believe the market picks up in 2025 from this year and Incap will be able to capture growth above the market as in this year.
This results in group growth of 9%, which I think is doable, especially against the fact that the market declined this year.
3. Profitability Drivers
Incap has always shown stellar profitability compared to its peer group. This is mainly explained by their Indian manufacturing. 67% of the personnel in Q3 2024 was in India, where the average salaries are lower than that of in western countries. Incap has strict cost control and they currently only have two employees in Finland. The business is pretty much run by the CFO and CEO. All the decision making has been rolled down to country organizations and the culture is based on accountability, responsibility and entrepreneurship in my view. I don’t see any reasons why this can’t continue apart from product-mix led gross margin fluctuations.
I don’t think the market that there is uncertainty about Incap’s profitability development. Incap has shown it can maintain above average profitability even if the top line decreases by double-digits like in 2023. In addition, Incap’s peer Note has been able to post decent margins in 2024 while their revenue is declining some 10% organically. This adds to my confidence about Incap’s future margin potential.
3. Cash Flow Drivers
As mentioned earlier, during the years 2020–2022, when Incap experienced rapid growth, its FCF was nil. This was due to the inventory building in order to secure availability as global supply chain was overloaded. Customers would place orders one year into the future, while normally they place orders to next quarter or so. Subsequently, Incap had to maintain high inventory levels. In order to meet its customers needs. This has now changed. Incap’s management communicated that inventory levels have been decreasing this year as the visibility for customers orders is worsening again. So while this adds uncertainty, it comes with better cash flow.
In the next years I believe cash conversion will improve and reflect the profitability better. This allows for possibly more acquisitions or other investments, while maintaining solid balance sheet. It's worth noting that Incap doesn’t pay dividends.
Scenario to returns.
Incap is a growth company and after the decline in revenue growth in 2023 Incap’s multiples have remained low. I believe that as we go into 2025 Incap is one of the companies to keep an eye on. If the growth picks up there is a chance for multiple expansion in addition to good profitability with improving cash flow profile.
The most important part of this text has been to clarify Incap’s revenue growth drivers. Incap’s valuation is largely dependent on growth estimates and here the largest customer play a big role. if the growth comes, Incap can see its value increasing. I will present the returns that would follow if the growth scenario I have presented here realizes.
Pennatronics acquisition consolidated in group figures since July 2023.
Without multiple expansion, Incap’s next two year IRR is 10% in the scenario I have input in my model. (This is just an illustration how the revenue development in this scenario translates into returns.) If incap is able to post growth rates of 9% and 7% in 2025 and 2026, there is a high possibility of multiple expansion. This would improve the returns up to some 20% IRR for the next two years.
