ii view: aftersales help diversified engineer Smiths Group

Sales are down but market-leading positions and a cost saving programme are helping group confidence.

First-quarter trading update to 31 October

• Underlying revenue down 2%
• Confident it will meet analyst forecasts for the full year
• Cash held of £413 million

ii round-up:

Diversified engineer Smiths Group (LSE:SMIN) reported a 2% fall in currency adjusted first-quarter sales, but that beat City forecasts for a fall nearer to 10%. 

Management pointed to the company’s market-leading positions and a high proportion of aftermarket revenues in aiding the resilient performance during a time of ongoing global disruption. It is confident it will meet analyst forecasts for the full year. 

Smiths' shares rose by around 3% in UK trading, leaving them down just under 10% year-to-date, although they are up over 70% since lows reached at the peak of the pandemic sell-off late March. Shares of automotive and aerospace engineer Melrose Industries (LSE:MRO) are up by a similar amount since late March but down by a third in 2020. 

Smiths supplies niche products to industries including oil & gas, mining, aerospace, and defence.  Challenging conditions in energy were partially offset by modest growth in industrials at its John Crane division. 

Industrial sales more than offset aerospace weakness for its high temperature fluids and gases components division Flex-Tek, while good momentum continued at its secure connectivity interconnect division suppling sectors such as defence. 

At its luggage scanning detection business, and despite pandemic hit airports, strong past aviation orders helped offset weakness in other security systems. 

Good progress for its strategic restructuring programme is on track to generate £30 million of savings this year, and the full £70 million saving come 2022. Cash of £413 million was held at the end of the quarter. 

ii view:

The company's John Crane energy component business generates the biggest slug of sales at around 37%, followed by detection at a third. The USA provides its largest market at just over 40% of revenues. Working on a common operating model, its businesses all share the common characteristics of being well-positioned in growing markets, technology-led, asset-light and with a high proportion of aftermarket revenues. 

That said, the medical business, with a focus away from industrial technology, is to be separated and given its own UK listing. However, given the disruption of the pandemic -  the business makes ventilators used by Covid patients - the separation remains on hold. 

For investors, exposure to virus hit sectors such as energy and aerospace fed into the mix for a one quarter fall in profit for continuing operations over the year to 31 July 2020. Strength from past orders could also reduce over coming months as deliveries are made but not necessarily replaced. However, the previous return of a dividend payment from its cancellation under Covid generates an income of over 2% in an era of ultra-low interest rates. Product and geographical diversity also offer attractions given the uncertainties from both Covid-19 and Brexit. In all, while some caution remains sensible, Smiths remains a well-managed business for the long term. 

Positives: 

• A diversity of business type, underlying customer and geographical location
• High proportion of aftermarket revenue

Negatives:

• Customers include Covid hit aerospace and energy sectors                       
• Exposure to unpredictable foreign exchange movements

The average rating of stock market analysts:

Buy