ii view: diversification aids engineer Smiths Group

A high proportion of aftermarket sales and a spread of underlying customer industries. Buy, sell or hold?

First-half results to 31 January

• Revenue down 7% to £1.15 billion
• Operating profit down 11% to £166 million
• Interim dividend up 6% to 11.7p per share
• Net debt down 6% to £1.08 billion

Chief executive Andy Reynolds said:

"The Group is united by the shared purpose of making a safer, cleaner and more efficient world.  The accelerating global trends of sustainability and digitisation play to the core strengths and capabilities of Smiths' existing business model. We continue to enhance the positioning of the Group for outperformance through targeted investment in innovation and disciplined transactions - including the planned separation of Smiths Medical by the end of FY2021, which will focus and simplify the Group and maximise value for all stakeholders.

"Whilst economic uncertainty remains, against the backdrop of our robust first half performance and the improving second half trends, the Group is confident of meeting market expectations for the full year and delivering long-term sustainable value."

ii round-up:

Diversified engineer Smiths Group (LSE:SMIN) today reported better than expected first-half results as demand from the semi-conductor and defence industries helped drive performance at its Interconnect components division. 

Group operating profit of £166 million, although down year-over-year, came in around 5% better than City consensus forecasts. Accompanying management outlook comments also pointed to improving second-half trends. 

Smiths' shares rose by more than 4% in UK trading, leaving them up by around 30% since pandemic induced lows this time last year. Shares for fellow engineer Spirax-Sarco (LSE:SPX) are up by a similar amount.

Smiths supplies niche products to industries including oil and gas, mining, airport operators and construction and domestic appliance markets. An 11% adjusted sales jump for the Interconnect division helped offset a 10% fall in adjusted sales at its rotating equipment solutions John Crane division, which is exposed to the oil and gas industry. 

Sales at its Detection business, including airport luggage scanners, fell by 6%, with sales at its construction and hydraulic applications leaning Flex-Tek business remaining virtually unchanged. 

The delayed separation of its medical business is to be completed by the end of this financial year. An ongoing restructuring programme remains on track to deliver a full £70 million annualised benefit come the full year 2022. 

ii view:

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. Aftermarket sales accounted for 49% of underlying revenue during this latest period. The John Crane business generates its biggest slug of sales at 36% of the group total. Of this just over half comes from energy, including both oil and gas and renewables. The detection business is second, making around 30% of overall sales. Geographically, the USA is its biggest market at just over 40% of sales.

Since 2016, Smiths has completed 11 disposals with proceeds of £540 million and 12 acquisitions for £1 billion. Its medical equipment business is being separated and will have its own UK listing given its focus away from industrial technology.

For investors, exposure to virus-hit sectors such as energy and aerospace have created headwinds. With under 5% of sales generated in the UK, foreign exchange movements can also impact, but the company's diversity of product, region and underlying customer sector offer attraction. A 6% increase in the interim dividend payment underlines outlook confidence, while a historic dividend yield of over 2% is not to be completely ignored in an era of ultra-low interest rates. In all, while some caution remains sensible, Smiths continues to be 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