13 great shares for the future

Despite all the talk of recession, this high-quality baker's dozen may be cheap at the current price.

Towards the end of July, Bodycote (LSE:BOY), Trifast (LSE:TRI) and Victrex (LSE:VCT) all made stock exchange announcements warning of difficult times ahead. Though Bodycote and Trifast said they should still perform as expected over the full year, such reassurances often fail to come true, and announcements like theirs may mean profit warnings in future. Victrex has already warned profits will be lower and so its third-quarter results were confirmation. 

The threesome have more in common than you might think. They all supply large manufacturers around the world, Bodycote treats metal components with heat to toughen them, Trifast supplies the fasteners that hold products together, and Victrex supplies a high grade thermoplastic used in components that must be very light and very durable. All three are uncertain about future demand due to general economic uncertainty and already lower demand in the auto and electronics industries.

Businesses like these have done very well since the credit crunch as manufacturers have globalised and simultaneously reduced the number of suppliers they use. They have global footprints and proprietary products, and so they have been favoured over local suppliers. Victrex is unusual in being one of only a handful of suppliers of PEEK polymer, but Trifast and Bodycote have compounded their advantage by buying up smaller rivals and folding them into their supply networks.

Harbingers of recession

The question on many investors, minds, I imagine, is whether these initial signs are harbingers of recession. If they are, it could be bad news for returns, at least temporarily. Of the trio, only Victrex performed adequately during the financial crisis of 2008, by my arbitrary stipulation that a company should achieve at least an 8% return on capital (it returned 11% in the year to September 20009 compared to its long term average of 28%). Trifast and Bodycote have upped their games since then though. 

There is a slightly different question weighing on my mind. These companies will perform relatively poorly at times, but because of their advantages they should come back stronger. Unless I change that opinion I intend to follow them through thick and thin. Even so, I use the Decision Engine to build portfolios, my own pension for example, and Money Observer magazine's model portfolio "Share Sleuth". I wonder if my predilection for global manufacturers and distributors makes my portfolios less diversified than they should be.

Manufacturing, manufacturing, manufacturing

Scan down the list of shares in the Decision Engine and manufacturing crops up a lot. The highest ranked share is XP Power (LSE:XPP), which supplies power converters to manufacturers of machines. Not all of its converters end up in industrial machines, it is a major supplier to medical equipment manufacturers, but the majority do. Renishaw (LSE:RSW) is also high up the list. It supplies machine tools to manufacturers. Both companies have global footprints. Like Trifast, XP Power's strategy is to win a bigger share of its biggest customers' business. 

Demand for the cars and washing machines made by the customers of companies like Bodycote and Trifast waxes and wanes because they are expensive, and when times are hard people put off making major purchases. The same is true for the customers of companies that make industrial machines like XP Power and Renishaw. When demand for their products falls, they buy less new equipment and keep older machines going longer.

XP's half-year results published earlier this month reported a decline in profit due to an almost 50% decline in revenue (ignoring the positive impact of an acquisition) from manufacturers of machines used to make semiconductors, from which it earns 17% of total revenue. XP Power does not expect the market to recover until 2020. Renishaw's full-year results, published on the same day as XP Power's half-year results, reported lower revenue and profit due to a decline in demand from manufacturers of electronics.

Adapt or die

Partly due to economic nationalism, globalisation no longer seems to be the one-way bet it has been, which puts buy and hold investors in an uncomfortable position. Export strength is evidence of a company's virility. Abandoning businesses that have performed well under certain circumstances because those circumstances appear to be changing is probably not the right thing to do. For a start, we do not really know what the future holds. And the best businesses will adapt as they have adapted before. XP Power, for example, will skirt around increased tariffs on trade between China and the USA as it shifts production from its older facility in China to its newer factories in Vietnam.

But just like good businesses, good investors must adapt. In selecting new companies to join the Decision Engine, I will seek to find some less tied up in the global supply chains of large manufacturers. That should, over time, increase the diversity and resilience of my portfolios.

13 shares for the future

Despite the gloomy outlook for global manufacturers three of the shares susceptible to these ill winds are among the 13 shares scoring seven or more out of ten, high quality companies that may be cheap at the current price. They are XP Power, Victrex and Renishaw. They have been propelled up the table by my confidence in the long-term potential of their businesses, and traders' doubts about their short term prospects, which has pushed the share price down, valuing the shares more attractively.

Since the last update, I have profiled System1 (LSE:SYS1), Castings (LSE:CGS), and Trifast. You can read the profiles for these companies and the others I have profiled recently by clicking on the hyperlinks in the table below:

The "Low confidence" section at the bottom is new. The label "low-confidence" does not necessarily mean the shares are wrong 'uns. It may just mean I have yet to work them out, or it has been more than a year since I last analysed them, or my analysis is not complete.

Richard owns shares in Trifast, Renishaw, Victrex, and XP Power.

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

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