A significantly better 2025?
Judges Scientific 2024
(You can read my in-depth report on Judges Scientific here.)
You think I’m obsessed with shareholder value, but I’m completely obsessed with shareholder value because this is really our mission: to create value for shareholders.
Source: David Cicurel (Judges’ CEO) during the Q4 earnings call
Judges reported its first earnings as a portfolio company last week. The stock had been beaten down running up to these earnings (down 30% off ATHs) but has recovered more than 10% from the lows it set last week:
What seems puzzling to me is that what Judges reported last week was already known because the management team had shared it in its trading update a few months back. However, I must say that the earnings did come with something additional: an exceptional call and more visibility into how temporary the headwinds really are.
2024: a year of (temporary?) headwinds
Judges has not had many down years in its history. Prior to 2024, the company had only suffered one negative total growth year (2020, caused by the pandemic) and two negative organic growth years (2014 and 2020). 2024 was a pretty rare event because it was another negative total and organic growth year, something that has only. happened once in the company’s history. Revenue was down 2% and organic growth was down 8%.
The fall in the top line created a significant drop at the operating level due to Judges’ fixed-cost nature, but the opposite (operating leverage) should happen once growth resumes. Operating profit was down a whopping 20%, and EPS was down 24%.
Taxes was a topic that caught me by surprise. Judges’ effective income tax rate is rising due to the change in the headline tax rate last year (the statutory tax rate increased from 19% to 25%). This means that the company’s tax rate should eventually converge to 25%, but Judges’ did two things to slow down the pace of the increase, one which seems temporary and the other which seems more permanent.
The temporary one is that the company used some tax offsets. The permanent one is related to the new R&D strategy through which Judges will apply for more patents. This will allow its subsidiaries to enter the UK patent scheme, through which profits derived from patented inventions only have to pay a 10% tax rate and not the statutory 25%. Management noted that both the offsets and this new “patent strategy” allowed Judges to save 200 bps in taxes in 2024 (the effective tax rate ended the year at 21%). All this said, management expects both the tax increase and the anticipated increases in national insurance to cost Judges around 3 million pounds annually. I discussed this permanent deterioration in the company's earnings power in my in-depth report because it might explain the drop in the share price to an extent. There’s no sugarcoating it, though: despite being outside Judges’ control, less money will be distributable to shareholders after these changes get enacted.
There was also some good “organic” news. The first one is that H2 was significantly better than H1. For example, orders in China were down 66% in H1, but ended the year down 33%, meaning H2 must have been considerably better. This is great because it somewhat demonstrates that what the company was suffering in China was temporary and is consistent with what many companies exposed to China have been reporting. The management team also mentioned they have made some tweaks to their strategy in China that they are excited about:
We’ve made some really good changes to our distribution network in China, which we think is going to pay some good dividends in the future using people across China that we already know can operate for our other businesses.
Revenue numbers were worse for the entire year than for H1 (meaning they did not improve), but what we should focus on here is orders, which are a leading indicator of sales. Organic order intake finished the year up 7% (+2% when excluding the new Coring contract). The green line in the graph below is a short to medium-term indicator, and we can see how it shot up significantly mid-year:
Cash conversion was also a highlight, as it improved significantly in H2. It ended the year at 122%, and operating cash flow was a whopping 34 million pounds. Despite the significant decrease in non-cash earnings, operating cash flow was actually up 9%! The metric needs its fair share of context, though. First, Judges received the money for the Coring contract in 2024, but revenue will be recognized in 2025. This naturally inflated cash conversion, which would’ve been 105% without the Coring contract.
Cash conversion of 105% is still exceptional, especially when considering that it was 63% in H1 and that management still believes that working capital is “too high:”
But at the same time, we still have higher working capital. Pleasing that we've gone back to 19% working capital as a percentage of annual revenue, having been as far up and as high as 25%. But we still have some way to go to reach our target of being back at 10%.
So, despite suffering several headwinds in 2024, Judges remained very cash-generative, and the company might be seeing the light at the end of the tunnel regarding headwinds. As I see it, Judges suffered three main headwinds in 2024, which are evolving as follows…
The Coring contract: there was no Coring expedition in 2024, but we know this was temporary as a new Coring expedition commenced in Japan in 2025. Cash from this expedition is already in the books (full prepayment), and revenue and profits will be recognized throughout the year. Due to the absence of the Coring contract in 2024, Judges took an impairment on Geotek (albeit it seems like a customary accounting adjustment more than something worrying). Management also noted that a fifth boat that can carry out a Coring expedition is being built in China although it’ll be tough to have two Coring contracts in the same year (albeit not impossible)
The delay of some projects: management noted in H1 that some 2024 projects had been deferred. The order book was maintained throughout the year, orders are trending positively, and a good chunk of these projects came “online” in 2025. Judges has historically not seen demand destroyed although the company has gone through periods of deferrals; this period seems to be no different.
China: as discussed above, China also seems to be recovering and management is excited about a new strategy it’s pursuing in the geography.
Based on the above, my assessment is that 2024 headwinds are temporary and that Judges' business has not been permanently impaired. However, the market does not seem to believe this despite now having much information to make a more accurate assessment.
M&A: Judges’ second-best year and quite a bit of dry powder
Unlike organic growth, M&A was a highlight in 2024. Judges deployed more than 20 million pounds into three acquisitions (I believe this includes earnouts): Luciol Instruments, Rockwash Geodata Limited, and Magsputter. It was Judges’ second-best year in its history in terms of number of acquisitions and cash deployed into acquisitions, which bodes well for inorganic growth in 2025 (as Judges will recognize a full year of revenue from these acquisitions):
Magsputter was by far the largest acquisition. Judges paid 12 million pounds for this holding company that owns the brand Teer Coatings. Management paid 6x EBIT for a business with an operating margin of 23% in 2023, which also grew profits by 23% in 2023. It seems like a pretty good deal, but note that these businesses tend to be pretty lumpy, so it’s maybe not the best thing to look at one year (unfortunately, I couldn’t find much information pre-2023).
Management shared some words about why they believe Magsputter was appealing:
And it's a company which is involved with coating, they're very expensive and sophisticated coating. A lot of things that we use in our everyday lives are coated, like your phone.
This is where it doesn't scratch. Or your glasses, which also don't scratch and sometimes have different properties. But these are very, very sophisticated coating. These machines that you see on the left, it costs something like half a million to a million pounds. And on the right, you see the hole which TeraCote uses to actually coat for other people.
So we have a service business as well as an instrument-selling business, and it is about half-half. And the coatings that we do are very sophisticated. It's not only the machinery which is sophisticated, but the recipe which is used for each client, to have the most successful coating.
The better news from M&A comes from the dry powder, though. Despite deploying significant cash into acquisitions, Judges still has plenty of dry powder to continue conducting acquisitions in the coming years. The management team always talks about deal equity, which is the result of the following formula:
Deal equity = 3x adjusted EBITDA (covenant) - current leverage + cash on hand
The company ended the year with a leverage of 1.7x EBITDA, meaning that the current deal equity is somewhere around 70 million pounds. This is pretty significant but requires context. For example, I highly doubt that Judges would be willing to lever the balance sheet close to the covenant. Still, at the same time, the current adjusted EBITDA is most likely depressed due to the operating deleverage the company suffered in 2024. To this, we must add that the company will generate cash next year, adding to its deal equity. Regardless of whether the amount is 60, 70, or 80 million pounds, what seems clear is that Judges has significant dry powder to conduct acquisitions, especially when we consider that the great majority of the debt is not repayable until 2028.
There also seem to be ample opportunities out there. Management declined to comment specifically on the pipeline but mentioned that deploying 75% of Free Cash Flow into acquisitions over the coming years is pretty realistic (I would agree). The inorganic opportunity remains robust.
Why 2025 is shaping up to be a much better year
So, taking all of the above, it seems like 2025 is shaping up to be a good year. I’d say there are numerous tailwinds…
Easy comps: 2024 was not a good year and might have created easy comps to see strong numbers in 2025
A strong order book (+19 weeks) bodes well for a recovery
The coring contract was signed in 2025 and revenue and profits will be recognized this year
2024 acquisitions contributing to 2025 revenue and significant deal equity to pursue further acquisitions
…
To this I would add management’s optimism. Management acknowledges that the performance is significantly below where they’d expect it to and they want to take the business on the right path as soon as possible. There’s definitely uncertainty coming into 2025, but there’s always uncertainty and the risk/reward seems skewed in investors' favor here.
Management discussed that they currently expect 2025 EPS to come in line with the market’s expectations. They did not share these and the sell-side research is not publicly shared, but based on estimates I see online, we should expect somewhere around 30% EPS growth in 2025. Note that these expectations don’t consider future acquisitions and therefore might err on the conservative side.
The topic of forecasting is also an interesting one. I went back to check how many 2024 numbers I had correctly guessed, and the answer was that very few…
I had assumed a drop in revenue of 0.4% and it dropped by 2%
I had assumed adjusted operating profit of 28 million (down 19%), and it was 27.9 million (pretty close by sheer luck!)
I was too conservative on operating cash flow which I had at 23.9 million pounds…it came at a whopping 34 million pounds
I forecasted an effective tax rate of 23%, but it was 21% thanks to the tailwinds I shared above
…
This simply shows that a model will most likely be wrong, which doesn’t mean it’s useless. A model should help us think about what needs to happen, and if we end up being too conservative (which I was with cash flow), then all the better because there’s only upside left in our investment.
All in all, Judges reported weak but not unexpected earnings, and everything seems to be trending much better in 2025. I believe that the headwinds are temporary and that Judges’ growth story remains intact and that’s why I decided to make the company a >4% position and will think about scaling it further in the coming months if it trades at attractive levels.
Have a great week,
Leandro