DCC: a top-notch company going cheap

Since listing on the London Stock Exchange in 1994, DCC (LSE: DCC) has been one of the market’s best-performing stocks. However, in the last seven years, the shares have disappointed, but have become much cheaper in the process. The management team has a proven record of value creation and is confident about the future. Given the stock’s cheapness, is it now time to buy it once again?

At its current valuation, DCC appears as cheap as it has ever been, having gone through a period of abnormally slow growth. In 2022, the management set out a vision of what the business is to look like in 2030. Since then, the company has outperformed that strategy, but the shares are little changed. Should the firm continue to make progress towards the 2030 milestone, the shares could return 300% in the next five years.

DCC was founded in the late 1970s as the Development Capital Corporation. The idea was to acquire good businesses and provide them with the capital needed to expand. It focuses on the energy, healthcare and technology sectors. Its biggest area of business is in consumer energy, where it delivers fuel to customers and operates petrol stations, but it is gradually switching to servicing the renewable-energy sector. In addition, it operates fulfilment businesses (logistics operations) for the healthcare and technology markets. In 2018, the company raised £600m in new equity. This was done because the management saw opportunities to accelerate the acquisition programme and felt that the additional money would give them credibility. Having gone through a period of high investment, in the time following the £600m injection, the company had difficulty making acquisitions.

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DCC comes off the boil

Shareholders in DCC have enjoyed a tremendous return. From listing in 1994 until 2018, the shares returned more than 6,500% including dividends. Since then, however, even including the payout, the return has been nil. The company has a long record of making sensibly valued acquisitions and integrating the businesses well. The total number of acquisitions since listing on the stock market is around 270. This strategy of buying and building businesses has ultimately been the source of the value creation. In 2017, the company invested more than £900m because the environment for purchasing decent businesses at attractive valuations was exceptional. At that time £900m would be considered a lot for the business given its size and hence the decision to raise £600 from shareholders in 2018. Unfortunately, the following year proved more challenging as the management struggled to complete as many investments as investors were expecting.

The next year was 2020, and Covid made completing deals fiendishly difficult. The result was that for the following three years (2019-2021), the total value invested in new businesses was less than in the single year before. As a result, the growth rate of sales and earnings sputtered and investors who had become used to consistent growth grew weary. Since the post-Covid reopening, the rate of acquisitions has increased. Nevertheless, the result of the decline in the growth rate has led to a decline in the valuation. Historically, the group has traded in an EV/EBIT range of around 12-18 times but now trades around eight times.

In 2022, the management of DCC set out its plans for the end of the decade. As has always been the case, it is dominated by investment in DCC Energy, which makes up around 75% of the group. The 2022 plan noted that a mixture of organic growth and already-announced acquisitions would lead to a doubling in annual operating profit by 2030. This looks conservative as it takes no account of any further potential acquisitions, which the group has proved itself capable of executing for three decades. An overall operating profit in excess of £1bn by 2030 seems a low hurdle. Should the firm manage to make further value-accretive acquisitions in the meantime, then an operating profit of £1.25bn is feasible.

DCC fundamentals

DCC has a tremendous record. Its period of poor performance was largely due to long-standing management discipline regarding acquisition valuations, mixed with difficulties making deals during Covid. In the past six years, the growth rate has been slightly below the long-term average, but the share price reaction has been to derate the equity by almost 50% of its historic levels. There are three possibilities; firstly, the business model might be broken and the high-return business of the past is no more. This would justify the low valuation, yet it is not the case: the group is ahead of the goals set out in 2022.

A second possibility is that the business model is intact, but the lower valuation is justified and reflects a market no longer willing to ascribe its old multiple. This is possible, but the growth alone should generate good returns to investors.

Thirdly, the business model is intact and the shares should trade around the old multiple. The board set out a plan for the eight years to 2030 in 2022; the business is ahead of this plan, suggesting that it is as good as it has always been. Should the company deliver on its goals and the valuation to go back to its old range then, including dividends, a return over the next five years of over 300% is realistic. Ultimately, DCC appears to be a rare thing in that it is both higher-quality and cheap. A good bet would be that it won’t stay cheap.

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