There's a lot to like at Smiths Group.
Boring businesses. I like them -- a lot. And FTSE 100 member Smiths Group (LSE: SMIN) is, happily, just such a business.
Smiths -- the ticker of 'SMIN' gives a clue as to its previous incarnation as Smiths Industries -- is clutch of five disparate technology and engineering businesses. These range from the John Crane division, which makes mechanical seals, to Smiths Medical, which makes medical devices, and Smiths Detection, which -- you guessed it -- makes detection equipment such as airport sensors that can detect things such as explosives, weapons, narcotics and contraband.
And in a desperate attempt to make itself sound more interesting, Smiths points out that the products made by another division, Smiths Interconnect, can be found on a number of space exploration vehicles including Galileo, Mars Observer and the Deep Space Probe, and will be on NASA's Mars Science Laboratory rover, which is due to be launched in 2011. I wasn't fooled, though. Deep down, Smiths is boring.
Sagging share price
It's also cheap. As Bruce Jackson pointed out exactly a month ago, Smiths is one of a number of companies that seem to have been left out of the general rise of the market since its lows of March.
At 838 pence before yesterday's announcement of the preliminary results for the year ended 31 July 2009, the share price is up, certainly, but is still well below where it was at the start of the year -- and well down from its pre-recession levels of 1200 pence or so.
Partly to blame was the shock announcement at the end of March of a ballooning pension deficit, which saw 14% knocked off the share price in a single day, as investors absorbed the implications of a deficit rise from £11 million to £464 million. Debt, too, had risen sharply, although currency movements were largely to blame.
So the P/E remains obstinately stuck at 10, which -- as the Financial Times has pointed out -- is significantly below the engineering sector average, a truly perverse rating for a well-diversified semi-defensive global engineering business.
Steady as you go
On Wednesday, the company announced its preliminary results for the year ended 31 July 2009. The market liked what it heard, pushing the shares up from 838 pence to 889 pence, a momentum that has continued since.
The news wasn't completely unalloyed joy. To begin with, "The business environment deteriorated dramatically in the past year," noted the company. That doesn't sound so good.
And more particularly, growth in the top line was flattered by the effect of currency movements and net disposals. On an underlying basis, excluding the effects of currency translation and net disposals, the reported increase in sales of £344 million to £2,665 million shrinks to a fall in sales of sales fell by £180 million, or 7%.
The dividend, too, was held at 34 pence per share -- a prudent move given a fall in underlying operating profit of 21%. But in an economic downturn where plenty of businesses have either slashed their dividend or abandoned it altogether, a dividend held rather than passed is a bonus. On today's share price, the dividend equates to a yield of 3.8%.
And the same general comment about the state of the economy applies. The world economy has been through a major recession, and a fall in sales -- and profits -- is to be expected. While not as defensive as (say) a supermarket such as Tesco (LSE: TSCO) or a pharmaceutical business such as GlaxoSmithKline (LSE: GSK), Smiths is a far cry from the automotive- and aerospace-focused GKN (LSE: GKN).
Costs out, cash up
Better news came in the form of news on the pension front. Included in yesterdays' news came an announcement that the company's final salary pension scheme has been closed, capping Smiths' future obligations and cutting the deficient from £464 million to £339 million.
Restructuring and rationalisation are also delivering cost savings, with £17 million achieved to date, and more promised. Likewise on the purchasing front, new computer systems have delivered savings of £9 million so far, with a further £11 million targeted next year.
These aren't big numbers, but coupled to an ongoing ERP system implementation (successfully rolled-out at 36 Smiths sites so far) should see efficiencies improve as well as cost-savings generated.
Finally, free cash flow generation of £256 million helped boost the corporate coffers, and was a significant improvement on the previous year's cash generation of £91 million. "Our priority for the coming year is to deliver further cost saving initiatives and to continue to generate strong free cash‑flow whilst investing in future growth," sums up chief executive Philip Bowman.
The verdict
For investors, Smiths pushes a lot of the right buttons -- both as a business, and as a share pick. It's cheap -- if not yet into full-blown 'value' territory -- and well-positioned to benefit from improving business conditions.
One for the watch list, certainly. The only fly in the ointment? Statements on record from chief executive Philip Bowman to the effect that he wants to sell some of the business, make further acquisitions, and create a Smiths that is more focused. As it's the lack of focus that is part of the charm of the company, long-term buy-and-hold investors will want to learn more about what exactly that focus will be.
More from Malcolm Wheatley:
Malcolm owns shares in Tesco and GlaxoSmithKline.
