Richard Beddard: is filter-maker Porvair worth your money?

by Richard Beddard from interactive investor |

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Designed to generate ideas for portfolios, our companies analyst’s revamped Decision Engine lists his top stocks.

Readers will know that I regularly publish updated results from an investing system of my own creation called the Decision Engine, which helps assess if any of a list of 34 companies are cheap or not.

Since last month’s Decision Engine update I have scored two companies: Games Workshop (LSE:GAW) and Porvair (LSE:PRV).

Games Workshop still gets top marks in terms of profitability, risks, strategy and fairness, but it has a hefty valuation. 

Porvair’s score is documented later in this article.

Although I have investigated two new companies, QinetiQ (LSE:QQ.) and Motorpoint (LSE:MOTR), I chose not to score them. Therefore I have not incorporated them in the Decision Engine, and they will not be ranked against the shares I follow most closely. 

The companies may be good long-term investments, as they are profitable and appear to have strong cultures, but I am not confident enough in Motorpoint’s finances and QinetiQ’s growth prospects to displace an existing company ranked by the Decision Engine. 

I am not keen to enlarge the Decision Engine either. Thirty-four companies is close to the maximum I can analyse every year, while also researching alternatives that might have better long-term prospects. 

The 34 companies in the Decision Engine are therefore the same as last month, although the rankings have shifted because of movements in share prices and therefore valuations.

Shares for the future

All of the shares in the Decision Engine are, in my opinion, good long-term investments, but some are better than others. Scoring these shares involves a lot of judgement but generally the higher up the list a company is, the stronger its ‘buy’ and ‘hold’ credentials.

Scoring Porvair

Normally I score companies as soon as I can after they publish their annual reports. But there is a seasonal rush of reports in the first half of the year and I sometimes fall behind. 

Today I am re-scoring Porvair, a company that closed its books last November and published its annual report in March.

The results were an improvement on the previous year, and the continuation of an improving trend that goes back over a decade:

Porvair has grown revenue and profit at a compound annual growth rate (CAGR) of about 10% over the last 11 years, and in the year to November 2019 return on sales (profit margins), and return on capital were above their long-term averages. 

The results for the year to November 2020, and perhaps for longer, are unlikely to be as impressive, though, thanks to the pandemic and worsening relations with China.

The impact of both threats to Porvair’s business were visible in the company’s accounts for the half-year to May 2020. 

Porvair continued to grow in the first quarter (December to February) but contracted sharply in the second (March to May).

Overall, revenue fell 8% in Porvair’s aerospace & industrial division, 6% in metal melt quality and 5% in the laboratory division.

Porvair is a specialist in filtration. The filters it makes have many applications. For example, some protect expensive equipment from impurities, such as the hydraulic systems in aeroplanes. Some improve the quality of aluminium and iron by filtering contaminants from molten metal, and others remove petrochemicals from ballast released into the sea by ships. 

Filters are often small components, but not always. This giant filter element was one of four made by Porvair for a Chinese chemical company. At over 3m long it has a filtration area of 47m2. The quartet of filter elements are the largest Porvair has ever made. Source: porvairfiltration.com

The Laboratory division, responsible for nearly 29% of revenue, specialises in equipment for testing water quality. Unlike the rest of Porvair it suffered a weak first quarter as Chinese laboratories shut down early in the pandemic, and recovered strongly as the scientific effort to beat Covid-19 accelerated.

Most of Porvair’s end markets are cyclical though, and the company is preparing to weather a recession. 

It has also written down the value of a Chinese metal filtration subsidiary. China is a price-sensitive market that Porvair had struggled to profit from. Ironically, the subsidiary made its first profit in 2019, but Porvair believes profit in future will be diminished by the deteriorating geopolitical situation.

Porvair should weather this recession. 

Its products must be consumed according to maintenance schedules. So although demand will decrease if fewer planes fly or industrial plants operate below capacity, their operators cannot defer spending completely as they may put off spending on capital equipment. 

During the great financial crisis the metal melt quality division made a loss, but demand otherwise held up well and overall the company remained profitable (return on capital bottomed out at 8%). 

Today, metal melt quality is arguably a better business than it was, earning higher profit margins from new patented filters, and Porvair is less dependent on it (it contributed 27% of revenue in 2019).

But the peril for aerospace customers is more acute now, due to travel restrictions aimed at limiting the pandemic. Aerospace contributed about 15% of revenue in 2019.

I like Porvair, and a recession might give us the opportunity to buy the shares at a reasonable price. This is how I score it:

Does the business make good money? [2]

+    High returns on operating capital
+    Excellent cash conversion
+    Modest return on sales

What could stop it growing profitably? [1]

?    Defined benefit pension obligation is relatively modest (72% of operating capital)
?    Cyclical end markets, e.g. metal and industrial filtration
?    Aerospace industry acutely impacted by pandemic
?    Small but pricey acquisitions. Average return on total invested capital is just 7%

How does its strategy address the risks? [2]

+    Develops and patents vital but relatively inexpensive components
+    Generates business from installed base e.g. in airframes, and gasification plants
+    Focus on technical differentiation, not price 
+    Creating mini-monopolies e.g. in aluminium cast-house filtration and water filtration
+    Acquisitions broaden and strengthen niches

Will we all benefit? [2]

+    Directors own 2.4% of the shares
+    Chief executive Ben Stocks is very experienced
+    Company explains itself well and is responsive to queries
?    Executives are highly paid
?    Very few staff reviews online

Are the shares cheap? [-1]

−    A share price of 522p values the enterprise at about £145 million, 21 times adjusted profit in the year to November 2019, a good year. The valuation is about 24 times normalised profit, assuming the business had earned its long-term average return on capital in 2019.

A score of 6/10 indicates that Porvair is probably a good long-term investment, but even though the shares have fallen 32% from their pre-pandemic peak in January their relatively high valuation still blunts the attraction.

Porvair is ranked 25th out of the 34 shares I track using the Decision Engine.

Company profiles

To find out how I scored each of the companies in the Decision Engine, please click on the links in this table: 

Name Description Profile
4Imprint Sells promotional materials like   branded mugs and tee shirts direct https://bit.ly/swFOUR2020
Anpario Manufactures natural animal feed   additives https://bit.ly/swANP2020
Avon  Rubber Manufactures respiratory   protection and milking equipment https://bit.ly/swBMY2020
Bloomsbury Publishing Publishes books and online   resources for academics and professionals http://bit.ly/swBMY2019
Castings Casts and machines parts for vans   and trucks, primarily https://bit.ly/swCGS2020
Churchill  China Manufactures tableware for   restaurants and eateries https://bit.ly/swCHH2020
Cohort Manufactures military tech. Does   research and consultancy http://bit.ly/swCHRT2019
D4t4 Developer and integrator of   Customer Data Platforms https://bit.ly/swD4T42020
Dart Flies holidaymakers to Europe.   Trucks fruit and veg around the UK http://bit.ly/swDTG2019
Dewhurst Manufactures pushbuttons and   other components for lifts and ATMs http://bit.ly/swDWHT2020
DotDigital Developer of marketing automation   software http://bit.ly/swDOTD2019
FW  Thorpe Makes light fittings for   commercial and public buildings, roads, and tunnels http://bit.ly/swTFW2019
Games  Workshop Manufactures/retails Warhammer   models, licenses stories/characters http://bit.ly/swGAW2020
Goodwin Casts and machines steel.   Processes minerals for casting jewellery, tyres http://bit.ly/swGDWN2019
Hollywood Bowl Operates tenpin bowling centres http://bit.ly/swBOWL2020
Howden Joinery Supplies kitchens to small   builders http://bit.ly/sw2020HWDN
James Halstead Manufactures vinyl flooring for   commercial and public spaces http://bit.ly/swJHD2019
Judges Scientific Acquires and operates small   scientific instrument manufacturers https://bit.ly/swJDG2020
Next Retails clothes and homewares https://bit.ly/swNXT2020
Portmeirion Designs and manufactures   tableware, candles and reed diffusers https://bit.ly/swPMP2020
Porvair Manufactures filters and   filtration systems for fluids and molten metals  
PZ  Cussons Manufactures personal care and   beauty brands, in the main http://bit.ly/swPZC2019
Quartix Supplies vehicle tracking systems   to small fleets and insurers https://bit.ly/swQTX2020
Renishaw Whiz bang manufacturer of   automated machine tools and robots http://bit.ly/swRSW2019
RM Supplies schools with equipment   and IT, and exam boards with e-marking http://bit.ly/swRM2020
RWS Translates documents and   localises software and content for businesses https://bit.ly/swRWS2020
Softcat Sells hardware and software to   businesses and the public sector http://bit.ly/swSCT2019
Solid State Manufactures rugged computers,   battery packs, radios. Distributes electronics https://bit.ly/swSOLI2020
Tracsis Supplies software and services to   the transport industry http://bit.ly/sw2020TRCS
Treatt Sources, processes and develops   flavours esp. for soft drinks http://bit.ly/swTET2020
Trifast Manufactures and distributes nuts   and bolts, screws, and rivets http://bit.ly/swTRI2019
Tristel Manufactures disinfectants for   simple medical instruments and surfaces http://bit.ly/swTSTL2019
Victrex Manufactures PEEK, a tough, light   and easy to manipulate polymer http://bit.ly/swVCT2020
XP Power Manufactures power adapters for   industrial and healthcare equipment https://bit.ly/swXPP2020

Richard owns most of the shares listed in the Decision Engine. He does not yet own shares in Porvair.

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.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation, and is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Disclosure

We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.

Please note that our article on this investment should not be considered to be a regular publication.

Details of all recommendations issued by ii during the previous 12-month period can be found here.

ii adheres to a strict code of conduct. Members of ii staff may hold shares in companies included in these portfolios, which could create a conflict of interests. Any member of staff intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. We will at all times consider whether such interest impairs the objectivity of the recommendation

In addition, staff involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles. 

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