In my opinion, companies that provide a specialist, bespoke service are some of the best investments you can make for the long term. Firms like Sanne (LSE: SNN) for example, which is a specialist global provider of corporate and fund administration services.
Administration services are tedious and time-consuming, but they are also extremely complex and companies can’t afford to get them wrong. With this being the case, I understand it is often more cost effective for businesses to outsource these functions, rather than build their own in-house teams.
Growth charging ahead
You only need to take a look at Sanne’s historical figures to see just how big this market for outsourced administration is becoming. From just £19m in sales in 2012, the company reported total sales of £113m in 2017.
The City doesn’t expect growth to slow down any time soon. Analysts have already pencilled in potential revenues of £157m for 2019. Alongside its first-half results release, published this morning, the firm confirmed today that it is currently on track to hit full-year growth forecasts. For the six months to the end of June, revenues grew 17%, although due to “an atypical first half weighting of results in 2017,” profit before tax declined 12% year-on-year on a constant currency basis.
And as well as the bespoke and specialist nature of the firm’s business, what I also like about Sanne is its relatively small size and cash generation. For the first half of 2018 for example, it booked an underlying operating profit margin of 30%.
These figures indicate to me that the company has plenty of capital to reinvest back into the business and expand into new markets. Bolt-on acquisitions in Madrid, Mauritius and Luxembourg show that this is exactly what management is doing.
As Sanne continues to build on its position in the market for administration services, I would be happy to hold the stock for the next two decades. Currently trading at a forward P/E of 21, the shares don’t come cheap, but I believe it is worth paying a premium to take part in Sanne’s growth story.
Bolt-on growth
Diploma (LSE: DPLM) is a business that I believe has similar qualities. The company produces specialised technical products for industries such as life sciences. This is not the sort of market where any old business can come and quickly grab market share, Diploma has spent decades building its reputation. And like Sanne, the firm is using its cash flow to acquire smaller businesses to help boost growth.
The latest acquisition was FS Cables, for a total cash consideration of £18m.
A combination of organic growth from its existing ops, as well as complementary growth from acquisitions, has helped turbocharge Diploma’s earnings expansion over the past five years. It doesn’t look as if experts believe this will change any time soon.
The City is expecting earnings to expand 26% in 2018, leaving the stock trading at a forward P/E multiple of 25. That’s a bit on the expensive side, but once again I believe this specialist business with enormous growth potential is worth a premium valuation. Over the past six years, earnings growth has averaged just under 10% per annum on a compound basis.
If this continues, it won’t be long before Diploma grows into its valuation.