Gamble of the week: beaten-up smoke alarms maker

Sprue Aegis (LSE: SPRP) makes smoke alarms and carbon monoxide detectors. Its shares have halved in the last month from 269p to 120p, after a fault with its batteries was revealed. Warranty payments usually cost the company under £1m a year, but it is now budgeting for the figure to spike to £6.8m, equal to a full year’s profit. “Dodgy batteries” mean the British firm expects a “deluge of guarantee claims from irritated customers”, says the Daily Mail. Managing director Nick Rutter, who co-founded Sprue in Coventry in 1998, has seen over £4m wiped off the value of his own shares.

But electrical goods can be a lucrative market. New legislation forces private landlords to fit carbon monoxide detectors and Sprue supplies B&Q, Tesco and Amazon. It also has public-sector contracts, supplying 90% of alarms bought by the UK’s fire brigades. Revenue has grown yearly for more than a decade, hitting £88m in 2015.

The fear is that Sprue has grown too fast, losing track of its suppliers. Management has tightened up its production line, says Investors Chronicle, but the panic “highlights the flip-side” of the risk involved when investing in small, fast–growing companies. The jump in warranty payments means earnings are now difficult to quantify.

Sprue is a “highly speculative investment,” says Shares – this battery issue isn’t the only potential hitch. Last year, a manufacturing facility in China had to be relocated because of plans to build a railway through the site. Its largest supplier, BRK Brands, is also its biggest investor, while its household brands, including First Alert and SONA, are only licensed until 2018.

Yet Sprue’s problems may not be as bad as they sound. Its alarms still work – some might just “chirp” prematurely. And the cash cost of the warranties will be eked out over six years, with a negligible impact on the balance sheet, which has £22m in cash and zero debt. The dividend is also unchanged at 8p per share, putting Sprue Aegis on a generous 6% yield. For a fast-growing company, that looks excessively cheap.