Does today’s news make this industrial stock a ‘must-buy’?

Should you add this industrial company to your portfolio?

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Shares in service distributor Electrocomponents (LSE: ECM) have risen by 13% today after the release of better than expected first-half trading figures. But can its improved level of performance continue and is Electrocomponents a better buy than industrial sector peer Rolls-Royce (LSE: RR)?

Electrocomponents’ first half saw it make notable progress on its initiatives to improve customer service levels, cut costs and stabilise its gross margins. In fact, the level of progress made in these three areas has been ahead of expectations and Electrocomponents anticipates that its underlying sales growth was 2% in the first half of the year. This was aided by a return to growth in North America in the second quarter of the year as well as better trading trends in Asia Pacific.

Furthermore, Electrocomponents has seen good growth in Northern and Southern Europe. This was a concern for many investors since the outlook for the region is highly uncertain, although softness in Central Europe has unfortunately remained.

In terms of costs, it’s is running ahead of targets. This shows that the business has scope to become increasingly efficient and with it now expecting to deliver £15m of savings in the current year, it’s quickly becoming a more streamlined business. This will help margins and with gross margins due to improve by a similar amount in Q2 as they did in Q1, Electrocomponents’ progress is ahead of schedule.

Looking ahead, the company has increased guidance for the full year. It now expects half-year pre-tax profit to be around £54m and for the full year it’s forecast to grow its earnings by 21%. It’s expected to follow this up with growth of 11% next year and with its’ shares trading on a price-to-earnings growth (PEG) ratio of 1.5, they seem to offer good value for money.

Upside potential

Of course, there are other good value opportunities in the industrial space. One example is Rolls-Royce. It’s also experiencing a period of significant change as its new management team seeks to turn around what is expected to become three years of negative growth when it reports its 2016 financial year results.

Clearly, Rolls-Royce is relatively risky since its financial performance is weak. As such, investor sentiment could come under pressure. However, Rolls-Royce is forecast to return to growth in 2017 when its net profit is expected to rise by 36%. This puts it on a PEG ratio of 0.6, which is much lower than that of Electrocomponents and indicates that its upside potential is greater.

Rolls-Royce’s low valuation also means that it has bid potential. This possibility is magnified by the current weakness of sterling and with the defence sector having a brighter outlook thanks to reduced austerity in the developed world, consolidation within the sector seems likely. As such, and while Electrocomponents is an excellent buy, Rolls-Royce is cheaper and has greater bid potential. Therefore, it’s the superior buy right now.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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