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Luceco’s operational gearing delivers impressive profits despite modest sales growth and potential economic shocks. However, the company’s visibility beyond the next quarter remains low.

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Operational Gearing Impact on Luceco’s Profitability

Luceco (LUCE), a manufacturer of diverse electrical accessories, has reported significant profit growth thanks to its operational gearing. Operational gearing refers to the proportion of a company’s cost structure that is constituted by fixed costs. Luceco’s case is noteworthy as the company is considerably dependent on the state of the economy, with half of its sales coming from a few large customers.

After a challenging first half, marked by de-stocking due to economic conditions, Luceco managed to rebound, generating higher profits on its fixed cost base. Despite a modest like-for-like sales growth of 1.7%, operating profits grew by over 9% to £24mn. The operating margin also improved by 80 basis points, reaching 11.5% as cost inflation subsided.

Trading in a Contracting DIY Market

The positive performance of Luceco comes in the context of a contracting DIY market, which shrank by 8% as it returned to usual trends after a pandemic-related boost. However, Luceco was able to offset this contraction due to improvement in non-residential maintenance and improvement (RMI), which delivered 8.5% revenue growth. RMI now contributes 20% of Luceco’s total revenue.

Navigating Economic Shocks

While Luceco may remain vulnerable to sudden economic shocks, the company showed resilience in navigating the extra freight costs imposed by the Red Sea blockade by identifying saving opportunities. This ability to adapt in the face of unforeseen circumstances provides an encouraging sign for its investors.

However, the company’s outlook beyond the next quarter remains unclear, with the management expressing positivity but providing little visibility for 2024. This uncertainty is reflected in the shares being rated at 10.4 times for 2024 by broker Numis, indicating that the market has already priced in a lot of the positive news.

Investment Perspective

The company has demonstrated its ability to capitalise on its operational gearing and adapt to challenging market conditions. However, its heavy reliance on a small number of customers and the overall economic climate, combined with the lack of visibility beyond the next quarter, presents risks that need to be carefully considered.

Despite these risks, Luceco’s ability to deliver profit growth amidst a contracting DIY market and navigate unexpected economic shocks, demonstrates its resilience and strategic capability. Therefore, it remains a potentially interesting option for investors who understand and are comfortable with the associated risks.