Two engineering stocks reporting today, Rotork (LSE: ROR) and Spirax-Sarco (LSE: SPX), have delivered impressive results. Both companies are moving in the right direction and are on track to meet expectations, at the very least. However, neither of them have investment appeal for the long term, since they trade on valuations which more than adequately factor in their upbeat outlooks.
Margins under pressure
Rotork’s third quarter performance was broadly the same as in the first half of the year. On an organic constant currency basis, Rotork’s revenue increased by 5.3% versus the same period of last year. Its investment in infrastructure has improved its operational performance, while its cost reduction programme is also progressing well.
In terms of its reported sales growth, Rotork’s top line rose by 28.9%. This benefited from weaker sterling and the contribution from acquisitions. In fact, currency changes are now expected to deliver a 10% benefit to both full year revenue and profit. However, Rotork continues to experience a challenging trading environment. This is causing margins to come under pressure, with this situation likely to continue over the medium term.
What a drag
It’s a similar story for Spirax-Sarco. The global macroeconomic environment remains in the low-to-no growth situation that was a key theme of 2015 and the first half of 2016. As a result, the company’s organic sales growth in the first ten months of the year slowed modestly from that achieved in the first half of the year as several large projects were not repeated.
Even though it faces a tough operating environment, Spirax-Sarco is on track to meet full year expectations. Its performance will benefit from a revised strategy, which seeks to deliver improved performance versus its markets through being more effective in identifying and generating engineered solutions to help customers with sustainability, efficiency and productivity. As such, Spirax-Sarco appears to be well-placed on a relative basis, although a poor trading environment is likely to be a drag on performance.
Uncertain outlook
Looking ahead, Rotork is forecast to increase its earnings by 7% in the next financial year, while Spirax-Sarco’s bottom line is expected to rise by 11%. Both of these figures are highly impressive given the challenges they face. They show that the two companies have the right strategies and sound business models, which bodes well for the long term.
However, the market appears to have already priced in their upbeat performance. In Rotork’s case, it trades on a price-to-earnings growth (PEG) ratio of 3.1, while Spirax-Sarco’s PEG ratio is 2.1. Both of these figures lack appeal and indicate that there is little, if any, margin of safety on offer.
Given the uncertain outlook both companies face and their somewhat modest underlying growth rates, this means that neither of them offers investment appeal at the present time. As such, it may be best to look elsewhere for more favourable risk/reward ratios.
