In my view, UK engineering conglomerate Smiths Group (LSE: SMIN) is one of the FTSE 100’s most overlooked stocks.
The company is a selection of different businesses all collected under one umbrella. The five divisions that make up Smiths are John Crane, Smiths Medical, Smiths Detection, Smiths Interconnect and Flex-Tek. These businesses are involved in everything from oil and gas engineering to hip replacements and airport security devices.
Struggling
Despite the group’s broad diversification, it has struggled over the past five years.
Profit margins have stagnated and earnings have slipped as a result. This year, the City is expecting the group to report earnings per share of 90p, down from 142p in 2017. Over the past six years, earnings per share have slipped by 2.3% per annum.
I think this stagnation has put investors off investing in the company, but that could be about to change.
In its results for the three months ended 31 October, Smiths reported an 11% increase in underlying revenues. On top of this, the company announced that its separation of Smiths Medical is progressing well and is on track to be completed in the next 12 months.
Unlocking value
Spinning off Smiths Medical could unlock a lot of value for shareholders.
Earlier this year, analysts said the valuation of the spun-off business would be roughly £2bn, based on earnings before interest and taxes of £170m. By comparison, the wider group has a current market capitalisation of £6.4bn.
Estimates vary, but according to my research and own figures, the value of the combined business could be 10% to 20% when it is broken up, compared to its current group structure.
And that’s the primary reason why I think that if you have £1,000 to invest today, Smiths could be the best investment to buy. Not only is the group a world-class engineer, but it also owns a world-class medical business that it is planning to spin-off during the next few months.
This spin-off will allow the Smiths medical business to thrive on its own and chase significant acquisitions using shares as currency, something it could not do as part of the group.
A price worth paying
The one downside of Smiths right now is the company’s valuation. The stock is trading at a forward P/E of 18, which looks expensive at first glance.
However, considering the fact that the business could see a valuation uplift of as much as 20% when it is broken up, I think this is a price worth paying.
Further, the company’s US peers trade at multiples in the 15 to 20 range. So, when compared to international competitors, the stock does not look that expensive.
As well as the potential for capital growth, shares in Smiths also support a dividend yield of 3%. This payout is covered 1.9 times by earnings per share, giving management plenty of headroom to increase the distribution in the years ahead as well.
