The penny share that could help set off a lighting revolution

We are on the cusp of an LED lighting revolution. And this small-cap British engineering company will be in the forefront, says Tom Bulford.

Electricity was an exciting but untamed force when, in September 1879, Thomas Edison said he'd use it to light up New York City. Nobody even believed he could do it. The public was still coming to terms with the idea of a lightbulb. So working out how to make distribute electricity seemed completely fanciful.

So journalists and politicians were left blinking in disbelief when he used underground mains to flood his Menlo Park laboratory with light. And the crowds swarmed into Pearl Street power station a couple of years later, as Edison instructed his chief electrician to throw a switch sending electricity bounding through the city's financial district for the first time.

In that moment, the electricity utility was born. And by 1907, more than 40% of America's electricity came from central power stations making Edison and many others enormously rich in the process.

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Why am I telling you this? Well because I think we are on the cusp of another lighting revolution.

Call it the LED revolution. It is predicted that within five years 60% of light sources will be LEDs (light-emitting diode). If that rate of progress sounds fanciful, consider this. Just about every traditional light bulb will reach the end of its life within the next five years and, at least outside the residential market, they are almost certain to be replaced by LED lights, which use far less electricity and last much longer.

Today LEDs only represent about 1% of the UK's light sources. But one company is prepared for the huge changes that lie ahead. I was keen to take a closer look, so headed down to STADIUM GROUP's (SDM) UK head office.

An industry veteran leads the way

On the surface LED lights look neat and compact. But behind each one is quite a large and sophisticated electronic engine. Making these engines is just one of the opportunities driving the growth of Stadium Group.

At Stadium's UK manufacturing plant in Rugby I was met by the chief executive, Stephen Phipson, and was given a tour of the factory by the business unit director, Ian Davies.

Phipson, a fifty year-old with big company experience in the electrical industry, gained at Plessey, Philips and Smiths Group is ambitious to expand Stadium. I will tell you about his big plans in a minute. But first let me explain what Stadium actually does.

Stadium designs and manufactures power supplies. If you are unsure what I mean by that, think of those black boxes that take electrical power and then supply it at the correct voltage to your computer. Last year this accounted for only 11% of Stadium's £45m of revenues, but 39% of its operating profit. The majority of Stadium's revenue comes from Electronic Manufacturing Services, a contract manufacturing operation.

Why this will be a British revolution

At Rugby I saw, being printed on large long and expensive machines, circuit boards destined for LED light engines, stair lifts, vehicle trackers and smart meters, to name but a few. You may wonder that circuit boards are still being made here in the UK. But Stadium is making a very good living, as Stephen Phipson explained.

While Chinese manufacturers are very good at producing in high volumes and long runs, they are not so good at making smaller batches. With a factory of its own in China, Stadium is able to offer both alternatives, and it will also either supply the circuit board on its own, or assemble it into the final product. This flexible approach, allied to the fact that it relieves its customers from the challenge of negotiating with Chinese suppliers, has made Stadium a steady performer in recent years.

But Phipson wants to take Stadium to the next level. Already, with the help of Charlie Peppiatt the ex-Laird group operations director who has spent several years in China, he has re-organised Stadium from geographical to functional lines and trimmed a significant amount from Stadium's raw materials bill. He managed this by implementing an overdue move to centralised purchasing. He has also beefed up the sales team and won new customers.

Why investors have high expectations for Stadium

But Stadium's facilities are still operating at only half of their potential level. As was evident from my visit this is an operation with high fixed costs and so any increase in throughput should have a disproportionate impact on profitability. Key to this, Phipson believes, is to offer a broader capability.

Electronic devices are becoming more sophisticated. Take a simple vending machine. The latest versions have radio frequency (RF) links and, under the terms of an EU directive designed to cut energy usage, they must automatically shut down unless they are being used. By adding the capability to add those RF links, Stadium could keep more work in its own factories, add value and reduce the customer's supply chain.

The City is expecting Phipson to make acquisitions and he is well aware that to gain investor backing he needs to make the first one a good one. He sees plenty of opportunities. Although Stadium's customers are currently in a rather cautious mood and demand is patchy', Phipson has seen several small UK companies that could fit the bill and, starved of bank finance, could welcome an investment from Stadium.

Stadium has long paid an attractive dividend and, at its current price of 73p it trades on nine times forecast earnings of c. 8p. But it is Stadium's net cash of £3m that is of greatest interest at present. When a big company man like Stephen Phipson joins a small company like Stadium, investors have high expectations. If he can spend that cash wisely then Stadium could attract quite a following. I'll be following its progress very closely in the year ahead.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.