Interactive Investor

Six favourite UK industrial shares with upside potential

Attractive end markets, improvement potential and modest valuations have attracted this team of City analysts to these stocks. Its best ideas in this sector include two new entries.

1st February 2024 13:44

Graeme Evans from interactive investor

A most-preferred list of the UK industrials sector now includes Rotork (LSE:ROR) and Chemring Group (LSE:CHG) after a City bank reviewed the stocks best placed for what’s likely to be another testing year.

The 2024 selection of Jefferies analysts also features FTSE 100-listed IMI (LSE:IMI) and Weir Group (LSE:WEIR) and the FTSE 250 pair of Hill & Smith (LSE:HILS) and Vesuvius (LSE:VSVS) after they kept their places from 2023’s list.

In the absence of a broader economic uplift, the bank recommends a focus on companies with self-help stories, strong balance sheets or those with high conviction in their end markets.

It remains “very comfortable” with its ongoing stance of avoiding expensive higher-quality names, resulting in “underperform” ratings for AB Dynamics (LSE:ABDP), Halma (LSE:HLMA), Renishaw (LSE:RSW) and Victrex (LSE:VCT).

Overall, it is constructive on the wider sector as order books and supply chains continue to normalise and the outlook for lower interest rates support a potential re-rating.

However, Jefferies adds that the year starts with heightened geopolitical tension and uncertainty of elections in countries that account for more than 40% of global GDP.

It warns it is a little early to make large bets on the near-term outlook, pointing out that the City has been quick to punish those companies that downgrade guidance.

Jefferies said: “The UK Industrials are a very durable bunch of companies, and after a number of tough years, where management teams have faced a range of headwinds, they start 2024 with another mixed macroeconomic backdrop.

“It is becoming the status quo for the sector, however, and we look for another robust performance in 2024.”

From an end market perspective, it is most upbeat on oil and gas, US infrastructure and aerospace and defence, while most cautious about European construction and general industrial.

Among the most-preferred stocks, Chemring is backed to rise 22% to 430p as the countermeasures and sensors firm looks set for a three-year period of accelerating top line and earnings growth.

This will be driven by defence and government investment in cybersecurity and intelligence, alongside a renewed move by nation states to replenish ammunition stockpiles.

Jefferies said: “What we think the market is missing, however, is that these two growth areas are higher margin and, therefore, there is also a beneficial revenue mix coming through, which (alongside operational leverage) should enhance margins and drive upgrades.” 

On the former stock market darling Rotork, Jefferies believes the oil and gas-focused flow control firm is in the best shape it has been for several years. It said margins were already among the highest in the sector and forecast to keep improving.

Jefferies added: “We are very upbeat about the US upstream opportunity, desalination, hydrogen and LNG markets, among others.” The bank recommends buying the shares, based on a 32% potential upside to a new 415p target price.

The bank regards the fluid and motion control specialist IMI as fundamentally undervalued, believing there’s been insufficient credit for how the business has been positioned for further growth and for its impressive margin performance. The price target is 2,090p.

Backing for mining engineering serviced firm Weir comes after management focused on improved margins, cash flow and its positive outlook at December's capital markets day. “Weir is evolving positively, in our view, and there is plenty more to come.”

Jefferies also notes the company’s aftermarket-led revenues stream that is becoming more structural and consistent in nature. It has a target of 2,575p, adding that shares trade on modest multiples relative to Weir’s closest peers and high-quality UK/EU industrials.

Although Hill & Smith was one of the sector's best performing stocks last year, Jefferies sees an attractive upside to a City-leading 2,280p as the road infrastructure firm’s three units benefit from spending under the US Infrastructure Investment and Jobs Act.

Jefferies points out the valuation of molten metal flow engineering firm Vesuvius remains modest, even after a decent end to 2023.

End markets are still reasonably challenging, but there is a big “self-help” story underpinning the equity case and the bank sees plenty of earnings momentum to come over the next few years.

However, it is the free cash flow generation and scope for multiple share buybacks that pique its interest. “With 39% potential upside to a new 675p target, there is plenty of runway ahead, in our view,” the bank added.

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