Specialized UK engineers find sweet spot as pandemic increases valuations

In a spa town in the Cotswolds is Spirax Sarco. The British engineer is making the special pumps and tubes essential for the production of Covid-19 vaccines, the steam systems that cook Heinz baked beans and the thermal electric heaters to safely launch NASA’s space shuttles.

But his profile barely exceeds his clients, despite being worth almost £ 11 billion.

“Although we are an FTSE 100, we are not a household name as we operate in very specific niches,” said managing director Nick Anderson.

Spirax Sarco is one of a handful of sophisticated British engineers focused on the hidden corners of modern industry whose valuations have jumped before and during the pandemic. Many have eclipsed more generalized, cyclical London-listed manufacturers such as IMI, Weir Group and Smiths Group, whose valuation has been pulled down by the medical division it has struggled to separate and sell since 2018.

Spirax Sarco shares are up 74% from pre-pandemic levels, even after more than tripling in the past five years.

His peers – Halma, Spectris and Renishaw – have followed a similar pattern and the trend is spreading beyond the UK. Valuations of specialist industrial groups, including Swiss actuator producer Belimo, Japanese sensor maker Keyence and Ohio-based laboratory equipment maker Mettler-Toledo, have far exceeded those of larger rival conglomerates.

The Spirax Sarco factory in Cheltenham. The company is one of a handful of sophisticated British engineers who focus on the hidden corners of modern industry © Andrew Fox / FT

Bankers are now reporting an unprecedented divide between these specialty companies and the more commoditized companies that struggle to consistently increase profits, in part due to pressure on margins from increased competition in low-cost regions like China.

“The premium that was previously 10 or 20 percent is 50 percent or more between high-quality people and the means of industrial technology. We are talking about two very different worlds, ”said an industrial banker.

One of the factors behind the attractiveness of UK niche groups for investors is that their highly specialized products are used in industrial processes in some of the most promising markets for the pandemic, such as pharmaceuticals and food and drinks. As customers viewed their products as essential, they were less vulnerable to cost reduction initiatives.

Anthony Plom, analyst at Berenberg, said investors were looking for resilient high-tech engineers during the pandemic’s “service slowdown”. “They’ve almost been treated like cash for the past 12 months because they won’t let you down,” he said.

Julian Fosh, fund manager at Liontrust Asset Management, a large investor in specialist UK manufacturers, said companies are adept at reinvesting profits and ensuring high returns on invested capital – a measure of how efficient they are. a business to generate profit.

“We buy and hold. You better have a quality business and pay a better price for it, ”Fosh said.

Other manufacturers have been more exposed to the pandemic. The operating profits of heat treatment supplier Bodycote, for example, were nearly wiped out last year due to its heavy exposure to the automotive and aerospace sectors. Vesuvius, a molten metal flow engineer, has been affected by the slowdown in steel production.

12 month (x) forward weighted earnings price line graph showing premium widening for high quality manufacturers

However, there is growing concern that successful specialist firms may start to appear overrated.

Equipment maker Renishaw was unable to find a buyer after recent research as its value rose from £ 3bn before the pandemic to £ 5bn.

The average ratio of enterprise value to expected earnings before interest, taxes, depreciation and amortization has reached approximately 34 times at Spirax Sarco, Halma, Spectris, Renishaw and Rotork. A basket of 11 other London-listed engineers trade at 20 times, according to Bloomberg data.

Investors and analysts reject the notion of a bubble, defending the premium for specialist engineers as justified given the expectation of improved earnings following the rebound in industrial production this year.

Andrew Williams, managing director of Halma, an Amersham-based company that manages 45 health and safety companies, said the group operates in “markets with long-term structural growth drivers.”

The £ 10.4 billion group has doubled its profits in five years and increased its dividend by 5% or more for 42 years by buying out smaller, often private, companies and expanding them.

The Spirax Sarco factory in Cheltenham

Investors and analysts reject the notion of a bubble, defending the premium of specialized engineers as justified © Andrew Fox / FT

“We have a 20-year mindset when it comes to an acquisition. . . The value we bring is to mature this business into a global business, ”said Williams.

As some manufacturers such as Spectris enter software, Scott Cagehin, analyst at Investec, said groups such as Spirax Sarco and Halma that help customers reduce their water and energy consumption are also becoming more attractive as an “ESG game” for investors. Exposure to oil and gas weighed on others, such as actuator specialist Rotork.

However, the market looks set to get tougher, with Beijing signaling last week that it plans to expand 10,000. “little giants” in niche manufacturing sectors, increasing pressure on British specialist groups, which derive the vast majority of their income from abroad.

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