Newsletter 43 – Dewhurst - Extraordinary resource and some concerns

This newsletter asks if Dewhurst (LSE:DWHA) possesses any extraordinary resources, potentially lifting its return on capital employed above the industry average?  (see chapter 10 of The Financial Times Guide to Value Investing for more on these ideas for strategic analysis)
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• Tangible?  None
• Relationship? Mostly ordinary resources.  However, they offer bespoke solutions to unusual requests from customers, architects, etc.  There is a strong emphasis on service and quality.
• Reputation? Mostly ordinary resources.  However, it has been said that ‘Dewhurst’ are synonymous with lift components in the minds of many architects.
• Attitude? A possible extraordinary resource.  They appear incredibly focused on their niches with a determination to be the best.
• Capabilities?  The combinations of skills need to supply solutions for clients may amount to an extraordinary resource.  This may be based on path dependency, i.e. the route they took, over a century, to get to where they are today, building up skills within the team (and name recognition over decades) may have created competitive advantages.
• Knowledge?  A possible extraordinary resource. The implicit knowledge of customers, design and technology built over time may allow superior returns relative to less knowledgeable competitors.

Are these possible extraordinary resources demanded, scarce and appropriable?

• Demanded?   Yes, customers do need these technical, design, service and efficiency qualities.   They need good relationships with a supplier of specialised components.  They need superior capabilities and knowledge of these niche products.
• Scarce?  I cannot find alternative suppliers.  That is my failing I suspect, rather than an absence of strong competitors.  However the returns on assets over the past five years indicates that there is not an abundance of similar companies that customers can turn to.
• Appropriable? Will the value created by the firm’s output accrue to Dewhurst or be appropriated by employees, suppliers, customers or others?  The suppliers of inputs, including employees, seem to have little bargaining strength and so are unlikely to appropriate a high proportion of the value (e.g. no ‘star’ employees on large bonuses).  Customers have greater bargaining strength, but Dewhurst’s history of high return on assets indicates that Dewhurst appropriates a great deal of the value they create as well as creating large consumer surplus for customers.

Can Dewhurst resources be leveraged?
Yes.  They are already applying their reputation, contacts, knowledge of continuous improvement in manufacturing, knowledge of customer requirements to the new businesses they acquire in closely-related niches.  They can continue to employ these competitive strengths to additional acquisitions.  Directors point to synergies in product development carried out in London having an impact on operations in America, Australasia and Asia.

Some questions

1. The large decrease in reported profit for 2013 is a concern.  Is it a one-off or will the company continue to suffer?  Note that operating profit declined by a more modest 27% and revenue by 15%.  The largest contributors to the reported profit decline were a goodwill write-off and a return to more normal keypad sales.
2. Will one of the giant engineering companies invade their markets?
3. Will they acquire more companies beyond their circle of competence or that are in industries with poor economic characteristics, as they did with Traffic Management Products?
4. There are a small number of lift manufacturers.  Could they gang-up to oppress suppliers such as Dewhurst? They have a history of getting into trouble with the antitrust authorities, e.g. fined €1bn by EC for illegal price agreements in 2000.  In 2014 Spain fined four lift companies for trying to keep rivals out of maintenance market.
5. I have not done enough digging yet to be fully confident in my industry analysis and competitive resource analysis.  What have I missed?  Who are their competitors?