Short-term trading issues at Invensys currently overshadow two attractive divisions.
I'll come clean. I'm a dustbin-diving investor that loves to find bargain shares that the market has dismissed as rubbish. The shares of industrial technology firm Invensys (LSE: ISYS) have been nearly sawed in two during the past year, including a 17% drubbing on 13 January following a third-quarter update. The report was not well received, as delivery delays and cost overruns have caused current-year profits to run significantly below last year.
A comedy of errors
2011 was a year that Invensys and its shareholders would no doubt like to forget. Former boss Ulf Henriksson abruptly stepped down in March, the shares were relegated from the FTSE 100 in May and free cash flow plummeted, in part due to the large working-capital swings that are so often witnessed at businesses that perform work under large, long-term contracts. Invensys also carries underfunded pension plans in the UK and US that require substantial annual cash infusions.
Against this backdrop, the firm's recent delays on delivering safety systems to nuclear plants in China and underestimating costs on rail projects in Saudi Arabia, Turkey and the UK is especially damaging. All this resulted in a dramatic rerating of Invensys shares – dropping from a P/E of 22 as 2011 started to the current level under 10.
Reasons to smile
After studying Invensys, I believe the company is a fundamentally sound business that's navigating a rough patch. It has been my experience over my investing career that these types of situations can provide excellent buying opportunities. Typically over a year or two as the company works through its issues, cash flow begins to improve, future prospects brighten and once scared-away investors return. That is where value investors who saw the calibre of the business early can make their profit.
The reality is that Invensys is a good business. In particular, the Operations Management division has relationships with nearly all of the world's largest chemical, petroleum and pharmaceutical companies,where its equipment and software improves the efficiency and profitability of production facilities. Within the past year, for instance, Invensys has installed its InFusion Enterprise Control System at an ExxonMobil (NYSE: XOM.US) plant and licensed several of its simulation software packages to Royal Dutch Shell (LSE: RDSB).
Invensys' Rail division provides software-based signalling and control systems that are in use in half of the world's busiest railway systems, including London, Madrid, and Vancouver. I see in the in the past three months, this division has scored big contract wins in Turkey and Saudi Arabia, and I get the impression the subsidiary will benefit from the expansion of high-speed rail and metropolitan transit systems around the world. This is particularly true in emerging market economies that are finding a need to rapidly build out their rail networks.
Invensys possesses a strong balance sheet, with £159 million cash and no debt. The one black mark on its balance sheet is the underfunded pensions, which carried a liability of £327 million at the end of the third quarter. On the bright side, the funding status of the group's pensions has improved considerably over the past two years and if Invensys could execute a buyout of its pension obligations I would view that as a strong positive.
Invensys consistently produces EBITDA margins in the low double digits, returns on equity near 30%, and in most years free cash flow well in excess of £100 million, though its free cash flow will fall well short of that level this year.
Foolish take aways
With its historically strong financials, attractive prospects in both Operations Management and Rail, and a share price that has been left for dead, I find Invensys to be an intriguing share right now.
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