Two FTSE 100 giants suffer in style rotation

Analysts at Jefferies reviewing UK industrials have shunned Halma and Spirax-Sarco, which have both experienced a 25%-plus fall in their valuations so far this year.

A sweep of 30 stocks in UK industrials continues to shun FTSE 100 giants Halma (LSE:HLMA) and Spirax-Sarco Engineering (LSE:SPX) despite a 25%-plus fall in their valuations so far in 2022.

Analysts at Jefferies instead look favourably on stocks with self-help and a cyclical bias, resulting in “buy” ratings for steel and foundry specialist Vesuvius (LSE:VSVS), heat treatment business Bodycote (LSE:BOY), motion and fluid control firm IMI (LSE:IMI) and mining technology operation Weir (LSE:WEIR).

Among the smaller names, it favours imaging solutions business Vitec (LSE:VTC), industrial threads firm Coats (LSE:COA), structural steel operator Severfield (LSE:SFR) and van rental business Redde Northgate (LSE:REDD).

Its review of the sector took place earlier this month and also upgraded airport detection business Smiths (LSE:SMIN) to a “buy” and downgraded defence countermeasures firm Chemring (LSE:CHG), instrumentation business Rotork (LSE:ROR) and high-performance polymer solutions firm Victrex (LSE:VCT).

In a note published today, Jefferies reflected on feedback from investors to its various recommendations and said the Smiths and Rotork calls were the most contentious.

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Overall, it said investors agreed there looked to be considerable value among cyclical stocks but that companies such as Bodycote and Vesuvius need greater clarity on near-term earnings risks around energy costs and raw material prices before they can re-rate.

On Halma and Spirax-Sarco, Jefferies said the debate with investors focused on the potential further downside risks after expensive high-quality growth stocks suffered significant punishment in this year's investment style rotation.

Jefferies noted this month that the premium valuation of high-quality stocks to cyclical ones had fallen from 90% at the end of 2021 to about 70%, but that this was still above the three-year average of 67% and 10-year average of 41%, leading to its cautious approach.

The scale of the recent share price decline at safety technology conglomerate Halma will be a shock to the system for followers of a stock whose dependable qualities earned it a place in interactive investor's Consistent Winter Portfolio for 2021/22.

Halma shares have risen 135% in the past five years but are down 28% so far in 2022, while Spirax-Sarco is up 166% over five years but down 27% this year.

Jefferies said it continued to regard Spirax as a “class act” with strong pricing power and robust fundamentals. The 130-year old business, whose steam and thermal solutions help to heat hospitals, produce food on an industrial scale or sterilise pharmaceutical equipment, has benefited from Covid-19 vaccines work at its Watson-Marlow fluid technologies business.

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On Rotork, the bank said there were a number of hurdles to overcome before it could take a more positive stance on the FTSE 250-listed business. It noted a disappointing fourth-quarter trading update and said it needed more evidence that the near-term pick-up in oil and gas markets will be sustained.

Jefferies said earlier this month: “The shares trade on healthy multiples, and while margins are attractive and the balance sheet is strong, our updated forecasts are below consensus and the group's backdrop does not currently warrant a re-rating,”

Overall, Jefferies is upbeat on the UK industrials sector but recognises the pandemic recovery will be far from straightforward due to supply chain challenges and cost inflation.

And while order intake is set to slow from very elevated levels over the next few quarters, it believes demand should remain healthy. 

Jefferies added: “We believe there is considerable value within elements of the sector, largely among the cyclicals, and alongside a global macroeconomic recovery, there continue to be numerous self-help stories that will drive EBITA margin recovery beyond previous peak levels.”

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The bank highlights Weir's end markets as being among some of the most attractive within its UK industrials coverage, with the group looking well-positioned versus its peers as customers seek solutions to help meet sustainability targets.

Its Weir target price of 2,090p compares with today's 1,598p. Jefferies said: “While the backdrop for the group is very positive, management needs to deliver considerably more, we believe. Specifically, a better EBITA margin and better cash flow.”