SMALL CAP IDEAS: Flowgroup looks as cheap as CHPs after having been overtaken by events last year

Posted on by Listify Me

‘Events, dear boy, events,’ was Harold Macmillan’s reply when asked what he feared most as Prime Minister.

Events are also the bane of most company bosses who don’t have the standard issue crystal ball.

Late last year events overtook Flowgroup, which was forced to suspend the UK launch of its combined heat and power boiler. 

An EU edict querying the amount of VAT charged on green products here in the UK meant it had to get down the cost of a product it was effectively giving away free. 

That’s because a hike in the tax rate would have to be borne by the company itself.

Thormostatic: Flowgroup has a micro-generation business, which has developed a combined heat and power boiler that generates electricity while it heats the home

Thormostatic: Flowgroup has a micro-generation business, which has developed a combined heat and power boiler that generates electricity while it heats the home

The market, binary in nature, was rather hard on Flowgroup when the news broke as its shares were heavily marked down.

At their peak, they were changing hands for almost 46p. Today they are worth just over 13p.

The reaction was as predictable as the bounce back that will likely follow as trust is rebuilt and investors sniff a bargain.

But before we assess the valuation, it is probably worth looking a bit closer at what makes Flowgroup tick.

It is two businesses in one. There is an energy arm, Flow Energy, which supplies cheap gas and electricity to around 100,000 customer accounts. It is a smaller rival to firms such as OVO Energy and First Utility.

It also has the micro-generation business, which has developed a combined heat and power boiler that generates electricity while it heats the home.

The fortunes of the energy arm have been transformed by a deal stuck with the oil major Shell, which will act as guarantor on forward contracts it signs for electricity.

This is a financially liberating deal that means it doesn’t now have to stump up £100 per customer in collateral – or a financially restrictive £10million if you have 100,000 customers.

It has also allowed the company to really put its pedal to the metal.

Analysts say Flowgroup needs to treble its current customer base to break even, which is expected to occur at some point next year.

FLOWGROUP AT A GLANCE

AIM ticker: FLOW

Value: £42mln

Current price: 13.1p

Year-high: 45.15p

Low: 9.75p

Longer-term the plan is to have one million home owners on its books, while running a direct-to-consumer model for selling its wall-mounted combined heat and power (mCHP) boilers.

Flowgroup will market its boilers to energy customers as well as using a network of specially trained, highly skilled, technology enabled ‘brand ambassadors’.

Currently it has 60 ‘ambassador firms’ with the team expected to grow to 120 firms by the year-end.

Chief executive Tony Stiff said initially it will take its time with the roll-out of the micro-CHP boilers, garnering as much information as it can about the product and the market. But by the year-end he reckons 10,000 homes will have one of its units.

The company is giving away the technology and will claw back the costs from the electricity generated by the units over the next five years.

After the initial term, home owners can opt to take the full savings from the electricity generated by the mCHP unit or split them in exchange for an extended warranty on the boiler that runs for five years.

Currently the unit, which costs customers around £3,500, is only economic in larger homes, but as the production run increases so the costs will come down.

At this point it is worth mentioning that Flowgroup has some pretty heavyweight backing in the form of Jabil Circuit, the New York-listed manufacturer of the iPhone.

Jabil is producing the units at a plant in Scotland and came in as an 8 per cent shareholder in May as it took part in a share placing in the City that raised £21million.

That cash will get the business through to break-even next year.

The opportunity for the boiler is huge with the European replacement market running at 9 million units a year on a total installed base of around 115 million installed units.

Flowgroup is gunning for less than 1 per cent of it, or around 1 million boilers.

It is, as the phrase goes, a ‘big ask’. But licence deals, where the company receives a royalty on sales, could help it hit this ambitious target.

The ‘game changer’, according to CEO Stiff, will be the cost, particularly if the company can get the retail price down to within a ‘couple of hundred quid’ of traditional boilers.

Clean up: Flowgroup will market its boilers to energy customers as well as using a network of specially trained, highly skilled, technology enabled 'brand ambassadors'

Clean up: Flowgroup will market its boilers to energy customers as well as using a network of specially trained, highly skilled, technology enabled ‘brand ambassadors’

That would allow Flowgroup to compete toe-to-toe with main manufacturers such as Baxi and Worcester Bosch.

Stiff is almost evangelical in his belief that this low carbon technology should be available to as many people as possible.

It is far more efficient than gas-fired power stations at generating electricity, therefore widespread adoption could help reduce Co2, a greenhouse gas. In other words every home should have one.

‘I want people to be empowered to take an interest in their own electricity,’ said Stiff.

‘It is a case of getting the cost of the technology down so Joe [and Josephine] Public has seen enough case histories to know it works. We are just rolling it out. After a year we will have a lot of collateral.’

Now that all important valuation. There are plenty of benchmarks for the energy business.

Customers tend to be worth around £300 each, which, based on the last published number, gives us a figure of £30 million.

If you add in the £18-£20million of cash the firm has on the balance sheet then it exceeds Flowgroup’s current £42million market capitalisation.

In other words the mCHP business, the jewel in the crown from management’s standpoint, is factored in at zero. Cheap as CHPs, you might say.

Cantor Fitzgerald reckons Flowgroup is worth 60p a share, or more than four times the current stock price.

The valuation ignores an important element of the business model. Flowgroup has created its very own retail channel.

It has 100,000 customers and the base is growing at a very rapid clip.

It has constant communication with its energy users and so at some point will be able to start selling additional products.

‘People will say we haven’t delivered and sentiment is poor,’ said Stiff.

‘But we have created an energy business that in a couple of years could be worth £300-400million.

‘If you layer on the micro CHP, which in my opinion has even greater upside, then Flowgroup is a great proposition.’

 

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