Smart Metering Systems: A defensive investment with significant growth potential

In times of uncertainty with a recession looming large, investors naturally seek out defensive stocks. These are shares in solid businesses that are revenue, profit and cash generators, with strong balance sheets, that are unaffected by the ebb and flow of the economic cycle. In the past then, the supermarket chains, the utilities and the infrastructure firms provided havens for stock market speculators as volatility began to rise. Financial re-engineering and regulation have put paid to the solidity of the likes of BT, National Grid and the merged regional electricity and water companies. Meanwhile, an existential threat posed by the internet and a surfeit of rapidly devaluing properties has tarnished the defensive credentials of Britain’s listed food retailers. So, it was great to stumble across Smart Metering Systems PLC (LON:SMS), which is as defensive as they come. Does what it says on the tin It’s a Ronseal-style company (in that it does what it says on the tin). But at the same time, it isn’t, as we’ll see later. SMS has 3.74mln meter and data assets under management generating annualised recurring revenue of around £76mln. This is a perpetual income stream (the asset might be replaced every 20 years or so) that is index-linked and benchmarked against the retail price index. SMS boasts an order book that should at least add a further £40mln to the recurring revenue base. For the income investors out there, it should be noted that the company’s dividend yield waxes and wanes between 4% and 4.5% (depending on the share price), which is a decent return, while it has also pledged to increase the pay-out at least in line with inflation. It should also be noted, these dividends are comfortably secured by existing long-term recurring cash flows, leaving the residual cash to reinvest in growth. Financially it is well set after recent deal with infrastructure specialist Equitix Investment Management to sell a minority of meters brought in £282mln after expenses. It put a benchmark valuation of 16.4-times ‘rent’ on the slightly older units in the portfolio that were sold. Debt-free The proceeds of the transaction, meanwhile, wiped out debt, which had crept over the benchmark thee-times EBITDA (underlying earnings), and has provided the company with a cash cushion of around £45mln, which is an excellent position in which to be during a pandemic. But, as chief executive Alan Foy points out, the company’s cost base naturally right-sized during the lockdown period (fewer people out in the field etc) and the coffers have filled a tad. A strong cash balance has allowed the company to repay the government furlough cash it took at the start of the outbreak. Bedrock business Foy calls the meters operation the “bedrock business” that will allow the business to move into “adjacent asset classes”. By adjacent areas, the SMS CEO means carbon reduction assets such as energy storage that will help the UK meet its 2050 net carbon zero target, which is 10-times larger than the meters market. It entered the virtual power plant arena following last September’s acquisition of Solo Energy, a business that links household batteries to the national grid using its cloud-based application. In sourcing assets, SMS is looking at areas of this growing green revolution that have the same characteristics as smart meters. In other words, they are likely to generate a recurring, perpetual revenue stream underpinned by legislation. Having the infrastructure to fit, service and support more than 4mln smart meters means SMS has the business set-up and technology into which to plug new services and products. Looking to the future In its bid to expand its offering, the company has teamed up with the infrastructure arm of Columbia Threadneedle. In doing so, it can share the risk with and leverage the balance sheet of the fund management giant, while bringing to the party expertise the investment group doesn’t have in-house. This tie-up will see the company earn a one-off payment for any assets it sources that are brought into the portfolio as well as a recurring management fee. So, to the point made earlier. SMS may look like a solid, dependable, dividend-paying, defensive play. But it also has a bit of ‘va-va-voom’ and the financial wherewithal to back up its growth ambitions. “This growth will be delivered in a sustainable way,” says CEO Foy. “The meter and carbon reduction assets deployed by SMS enable an acceleration towards a green and clean environment.” This, he adds, is “aptly reflected” by the group’s tag line: ‘play a leading role in the transition to smart and low-carbon energy systems’.