Shares for the future: the best stock on my subs’ bench so far

This week, I’m introducing another potential candidate for the Decision Engine, selected because it has grown dependably, and I think it may be distinctive and directed.

Instead of adding candidates immediately to the Decision Engine, I’m adding them to a different list. Let us call it the subs’ bench.

• Invest with ii: Top UK Shares | Share Tips & Ideas | Cashback Offers

I can mull them over and, when it is time to retire a low-scoring member of the Decision Engine, I’ll be able to pick from a handful of promising substitutes.

Scoring Volution: high returns

Volution Group (LSE:FAN) manufactures ventilation products for homes, offices, hospitals and shops. Fans, in other words, and whole-house ventilation systems.

The Past (dependable) [2.5]

• Profitable growth: 12% CAGR in revenue and profit [1]
• Strong finances: Strong cash flow, substantial obligations [0.5]
• Through thick and thin: Lowest RoC 34% in 2020 [1]

Since it listed on the stock market in 2014, Volution has grown revenue and adjusted profit at a compound annual growth rate of 12%.

Profit margins are more than adequate and Volution’s businesses generate about 50% return on capital in a typical year.

However, they are almost entirely financed by external capital. Net obligations (including leases) at the end of the financial year in July 2024 were 78% of operating capital.

That is the lowest level of indebtedness since 2015, but still above my 50% benchmark.

No doubt Volution believes that it can afford the interest on these obligations because of its dependable profits and strong cash flows. Cash returns after capital expenditure are typically 90% of adjusted profit.

• Stockwatch: possible bid target and hedge against IHT
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

That is a reasonable assessment. For a manufacturer, Volution does not require much capital. Its debt to capital ratio is not just high because of its financial obligations, but because I’m comparing it to something small.

That low capital requirement may stem from the fact that Volution is mainly an assembler. It makes the cases and fills them with components often made elsewhere, usually to its own specification.

If we think about debt in terms of how long it might take to repay it, it takes on a different complexion.

Volution could probably save up enough cash to outweigh all its financial obligations in a couple of years if it were to direct free cash flow into the bank.

In the decade since Volution floated it has spent much of it on acquisitions, instead.

The Present (distinctive) [3]

• Discernible business: Manufacture of ventilation systems [1]
• With experienced people: Experienced chief executive [1]
• That creates value for customers: Quality, availability, sustainability [1]

Better ventilation means healthier air indoors. Volution mostly improves the air in our homes, but the commercial market, places such as shops and offices, contributed a little over 20% of revenue in 2024.

Public awareness of the importance of indoor air quality increased during the Covid pandemic. Tightening regulations and the prosecution of public and private landlords for failing to prevent condensation and mould means Volution is benefiting from an “acute focus” on poorly ventilated homes (aka sick building syndrome).

Regulations to improve energy efficiency and reduce emissions from buildings are also boosting demand for ventilation systems that expel stale air but not heat in winter, and help cool houses in summer.

Volution differentiates itself by making quieter, more automated and more environmentally sustainable products, and by providing services to larger contractors, such as site surveys.

During the decade since it floated, the company has diversified geographically, doubling revenue from overseas from 30% to 60% as it has acquired businesses in Europe and Australasia.

Source: Volution annual report 2024

Chief executive Ronnie George has guided this transformation. Formerly the managing director of Vent-Axia, one of the company’s UK subsidiaries, he led a management buyout in 2012.

The Future (directed) [2.5]

• Addressing challenges:Growth, competition [1]
• With coherent actions: Innovation, acquisitions (sometimes large) [0.5]
• That reward all stakeholders fairly: Employee/customer-centric vibe [1]

House building and construction activity is sensitive to economic conditions, yet revenue has declined only once since the company floated. That was in the year to July 2020, when the onset of the Covid pandemic shut the economy.

While construction is a cyclical activity, acquisitive growth is not masking underlying instability in the business. Excluding the pandemic years, Volution has achieved modest but steady organic growth:

Source: Volution annual reports

The average growth rate of 4.1% at constant currency (3.9% reported) is within Volution’s current “expected range” of 3-5% organic growth.

The company says that it earns more than two-thirds of revenue in the refurbishment market, and that has contributed decisively to its resilience. Less than a third of revenue, by contrast, was from new builds.

As Volution gets bigger though, it needs to make bigger acquisitions to keep the inorganic element of growth climbing near the historic rate.

The company recognises the consequences of bungling a larger acquisition is greater than bungling a small one, but post-year end it made its biggest so far.

• What is tipped to be the best asset class of 2025?
• The Income Investor: dividend stocks still appeal after Budget

The target is Fantech, operating in Australia and New Zealand. The deal is not yet done, because it is being scrutinised by antitrust authorities. The price is £144 million, roughly double 2024 cash flow (after capital expenditure).

Fantech brands would augment those of Volution’s three existing Australian subsidiaries, and catapult the region to prominence in the group. Including Fantech, the company reckons Australasia would contribute about 30% of revenue.

The company will bear scars from the acquisition for a few years. It will be more indebted and Return on Total Invested Capital (ROTIC), the measure I use to determine whether a good business is a good acquirer, will fall.

This is because ROTIC includes the value of the acquisition at cost in the denominator (capital), but it can take a few years for companies to integrate large acquisitions, and for the full benefit to be seen in the numerator (profit).

Investors rightly question whether “synergies” from large acquisitions will justify the cost. Often they do not. But Volution has been a good acquirer. ROTIC in 2024 was 19% after corporation tax at the standard rate, which is impressive. Even at its lowest point in 2020, Volution achieved 12% ROTIC.

I have invested in companies with seemingly high levels of financial obligations before, when they have simple, repeatable and highly profitable businesses.

Volution’s focus on one kind of product, increasingly required in most buildings, and its modest capital requirement, make me think it may be.

It is easy to imagine that as it gets bigger, Volution can source components more cheaply, increase the range of products it sells through its subsidiaries, and consolidate manufacturing and assembly sites.

Meanwhile, the company’s purpose to deliver healthy air sustainably is laudable and the headline figures show it is edging towards sustainability. The carbon intensity of Volution’s operations is considerably lower than it was in 2020, and 78% of the plastic it incorporates in products is recycled. 

• Stockwatch: a tax warning for UK and US investors
• Share Sleuth: performance over 15 years, and a share sale

Since this year Volution conducted its first group-wide employee engagement survey, we have nothing much to compare it with. The company runs apprenticeship and management training schemes and seems to have good intentions.

A self-reported score of 74% would usually be considered good and is, as Volution says in so many words, something to build on. 

However, over the last three years, when the company has performed well and often paid out close to the maximum bonus and long-term incentives, the gap between executive pay and median pay has widened.

In 2024, Ronnie George earned nearly 80 times median pay of about £26,000.

The price (discounted?) [-0.8]

• No. A share price of 556p values the enterprise at about £1.2 billion, 22 times normalised profit.

A provisional score of 7.2 means Volution may be a good long-term investment.

It is by a nose, the best of the subs picked so far:

Scores and stats: Richard Beddard. Data: SharePad and annual reports
Click on a share's name to see a breakdown of the score (scores may have changed due to movements in share price).

23 Shares for the future

Here is the ranked list of Decision Engine shares. I review the scores at least once a year, soon after each company has published its annual report. The price scores are calculated using the share price prior to publication.

Generally, I consider shares that score 7 or more out of 10 to be good value. Shares that score 5 or 6 out of 10 are probably fairly priced.

Softcat (LSE:SCT) and YouGov (LSE:YOU) have published annual reports and are due to be re-scored.

Scores and stats: Richard Beddard. Data: SharePad and annual reports
Click on a share's name to see a breakdown of the score (scores may have changed due to movements in share price)
Shares marked with an asterisk (*) have been re-scored, click the asterisk to find out why.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.  

Richard owns many shares in the Decision Engine. He weights his portfolio so it owns bigger holdings in the higher-scoring shares.

See our guide to the Decision Engine and the Share Sleuth Portfolio for more information.

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard