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Two years ago most investors had written-off Titon (LSE:TON) because it went through a half-decade of only breaking even. Since then the share has risen 150% on the back of an amazing profit recovery in Korea and some exciting growth in mechanical ventilation with heat recovery sales.
But how sustainable are these recoveries?
Korean hardware
The largest part of this business is manufacturing and selling window vents – simple passive products.
When this business started in 2008 Titon UK provided the expertise and its Korean partner supplied local knowledge and marketing. Building regulations and demand from social housing helped the business take off.
Porter’s Five Forces:
1.Rivalry within the industry. Currently there are few competitors. But I get the impression they are on their way. Potential rivals will have seen the high margins Titon Korea makes, and are likely to push down prices as they enter.
2.The power of customers over industry players. Customers cannot turn to many rivals yet, so margins can remain reasonably high for a while. But this may change.
3.The power of suppliers over industry players. Raw materials are generally bought in highly competitive markets so suppliers have little power to suck out value.
4.The potential for entry of new competitors to the industry. Few barriers to entry. Perhaps there are some reputational and relationship advantages accruing to the incumbents, but these are not insuperable.
5.Substitutes. None.
Conclusion: low barriers to entry mean that it will be increasingly hard to sustain margins.
Competitive Resource Analysis:
T – Tangible assets. No tangible assets providing Titon with an extraordinary resource.
R – Relationships. Titon has built some strong relationships, e.g. with employees and customers, but I think it unlikely that this amounts to an extraordinary resource. Can high margins really be tolerated by customers on the back of strength of relationships?
R – Reputation. Its market-leading position and quality reputation might help it maintain its high ROCE for a while, but these are simple products that customers buy mostly on price, so “sustainability” is doubtful.
A – Attitude. Unlikely to be extraordinary.
C- Capability. Perhaps they are extraordinarily good at marketing in Korea, but I have no evidence for this, unless you count the profit margins currently achieved.
K – Knowledge. Unlikely to be extraordinary because in the long run it is not that scarce (potential rivals can acquire it).
Conclusion:
Until the competition really gets going ROCE will be high, but freedom of entry leaves a serious worry regarding the multi-year view.
Mechanical Ventilation with Heat Recovery
In the depths of the recession following the financial crisis Titon started designing, building and selling MVHR units. These are much more sophisticated products than the hardware divisions make. This sophistication, in itself, may bring some pricing power. A good sign is that turnover has risen significant recently to £4.67m (but profits are not stated).
Porter’s Five Forces:…………To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
