A good solid value play?

23rd Jun '09 by djpreston

7 comments 3168 reads

Smiths Group has underperformed the FTSE by roughly 20% since the start of the year.

Whilst the interim results were not great, with the shares plunging to 670p by the end of March, they subsequently rose again to c760p in mid May since when it has been more of less downhill to 649p on 19th June. Does this provide an opportunity?

Laying my cards on the desk, I have to disclose that since Friday we have been buying SMIN in a relatively big way.

Right, whats the attraction to the business?

Most associate SMIN with Aerospace. That of course went in the sale (and cash back to shareholders) to GE. This leaves SMIN focussed on five main areas:

John Crane
Detection
Medical
Interconnectors
Flex-Tek

For more information on the variosu groups, you cant beat the company website, which is very helpful

http://www.smiths-group.com/smiths_group.aspx

What appeals to me is that the company has a very good track record for long term growth and wisely startted to restructure its business in Q3 last year. and should now be starting to feed through the benefits of the cost reduction and efficiency programme. I have no doubt that there will be more cost savings to be announced in the full year results in September but would expect to hear positive noises from the company with regard to savings achieved and margin improvements so far.

The business is highly diversified with across business areas and also geographically though perhaps more of a US bias and less SE Asian exposure than i would ideally like. This US presence should/could also be a positive as I will discuss below.

Earlier this month Smiths confirmed that divisional margins coudl expand, even during the downturn with the restructuring possibly adding 500 bps by 2011. This was at an investor event by the way.

The key concerns of the market (resulting from the interims) seem to be:

Detection division
Pension deficit
Cash generation

Addresing these in order:

Detection

This was a big disappointment since the market had assumed that detection equipment spending would be resilientin any downturn, however, H1 revenue growth was down in the region of 11%. The key focus here is on the ramp up of spending by the Us, especially the Dept for Homeland Security over the next year (mainly 2010).

In May the DOHS received a 6% increase in its budget with…

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MrT

25th Jun '09

Interesting stuff. I see Deutsche have re-rated it (target 900p)- http://www.newratings.com/en/main/company_headline.m?id=1929420. Any colour as to why? All this summary says is:

The restructuring plan initiated by Smiths last year has begun to yield results and the company’s end markets are expected to recover from 2010 onwards, the analysts add.

I like Smiths - it seems like a "boring", messy conglomerate, just the sort of thing the market might misprice from time to time, but I do really worry about the pension deficit. Your estimate of £400m is somewhat reassuring and has "a logic" but what's the confidence interval?! As I mentioned on this thread - http://www.stockopedia.com/forum/view/27692/weak-underlying-results - it jumped from £11m to £460m last time...

djpreston

26th Jun '09

In reply to MrT (post #1)

Ah the wonderful world of pension deficits.

As with most companies with historic pension funds have always had relatively big swings in deficits and suprluses, especially over the last decade or so due to the taxation changes, the poor market performance and most importantly the longevity calculations. I guess it is a matter of faith to a degree as to how wound up you get when it comes to a pension fund. I dont like deficits and tend to avoid those companies that are effectively pension funds with a business attached. Im looking at you BT, BA and so on. The Smiths scheme is what Id view as "withing tolerance" it is not too big as to pose a massive risk (IMO) to the financial forecasts for the company, espcially as they are already making additional contirbutions and have addessed the triennial review as per my header. Id expect that this triennial review will in time have proved to be at the nadir and the next one should be much more favourable.

Gradders73

I know the company pretty well, and they have a proper awareness of the issues around the scheme and consider the risks manageable. It's not that big a fund and it is closed (closed at least 7 yrs ago as I recall).

They have divested themselves of auto and aerospace, which looked a good move at the time and a better move now and are a pure widget manufacturer with a diverse client base in general industry and medicine, which makes them more resilient in downturns than most.

This is a solidly run company and the shares pay a decent dividend, I wouldn't say it's going to go up hugely but I wouldn't lose sleep over having this in my pension pot..

In reply to Gradders73 (post #3)

Hi Gradders

Yep, that pretty much sums it up for me. Solid, well run, wiling to reaclise assets when price is right (sale of Aerospace was seen as heretical behavious in this neck of the woods) and shouldnt give you sleepless nights. A simple (ish - is anything simple in these markets) 25-30% over a year would be about right Id have thought with the more patient holders probably seeing a lot more over the years.

Thanks for putting down what I should have wrt the pension scheme.

Darron

11th Sep '09

Just an update here.

Seems that the 25% - 30% came a wee bit earlier than a year and so we decided to slice some off the top to put the gain into cash.

SMIN now seems decent value but really unlikely to excite in the short term IMO (unless there is a bid) but still long term quality. Lightening the load, (especially ahead of next figures) jst seemed to make sense. Sold around 888p so so thats roughly 32% gain. With the initial investment left behind.

Do still wonder if MRO is about to make a move on someone - their results were cracking and more sensible disposals done. With the shares up from 95p when we bought to 160 odd, Im very happy to let that one run.

30th Sep '09

Just a quick update as I'm stuck in the car....

Results seem to be very positive with good free cashflow, pension deficit falling, good operational results and maintained div.

I'll have a closer look when I get in.

Balls - just lost my edit of the above post so this is a cut down version.

Anyway, key developments section in the RNS is worth a look. Gives all the good news.

http://www.investegate.co.uk/Article.aspx?id=200909300700169095Z

Results seem to be in line with/slgithly better than expectations though some of those expectations were reduced recently.

The worst performance came from the Detection division where new contract tenders have been delayed. Miltary side was strong but Ports and Broders was weak. This, however, is still a potential source of major new business given the US legislation to have 100% of cargos arriving in the US scanned by 2012. DHS budgets will be funding this.

Medical saw good margin improvement and was the key "beat". Action taken has improved margins going forweard (flat this year) due to exit of diabetes market. Consumables were strongest and sales of hardware fell but stabilising and then improving as H2 came to an end (continuing into 2010 FY).

Flextech did quite well matching expectations given tis end customers - aerospace, US housing and general industrial. Strong Military aero offset weakness in civil.

John Crane - again good aftermarket supplies but weaker OE sales to O&G (not surprising given the capex problems of O&G cos over the year). Margins picked up due to the restructuring programme. OE sales still likely to be weak in H1 2010 though (according to co).

Interconnect was in line with expectations. Again military remained strong but wider markets - wireless, industiral and auto were weak and remain challenging (possible pointer on the outlook for wider economic pick up??).

Overall this was, I feel, a solid performance, much as I expected from the header. SMIN management are no mugs and are conservative. The increase in margins and cost savings and especially cashflow were very welcome. The div, whilst unchanged is covered 2.1x and wont be increased in 2010 as the co targets a 2.5x cover.

One concern is the visiblity of orders going forward, especially outside military, which itself could possibly come under pressure due ot budget problems?? Nevertheless, the div is a solid 4% and the shares are on c 12x 2010 estimates. That a significant discount to the sector peers and historically low for the group. Givent he quality of management, that still looks decent medium/longer term value.

However, and you knew there would be a however, is there much scope for the shares to move up significantly n the short term? For that to happen we would, IMO, need either the oft mooted break up bid or real confirmation that the economic pick up is here and continuing. I still feel that it would be a perfect break up target for a predator.

The shares are now back up to where I sliced some out (see above) but I have to admit Im stuck right about now. Tempted to sell and increase cash (as Im not quite as bullish as Id like and heck, it has hit the TP I set out in the headr back in June) but then again, where can I find a good quality company like this on these multiples? Difficult decision.

A good solid value play?

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Djpreston

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