Smiths Group
Uninspiring performance raises questions on delivery of MT Targets
The next company I’ve picked, is Smiths Group. As suggested by the stereotypical farmer in the ‘Honest Work’ meme, Smiths Group’s capability of providing world-class engineering solutions in critical markets is ‘honest work’, but the uninspiring performance over the last five years leaves investors wanting for more.
Description
With its origins in a jewellery shop, S Smith & Sons over 170 years ago, Smiths Group is a diversified engineering business listed on the LSE with a market cap of £6bn.
The group provides engineering solutions for mission-critical applications to solve tough problems for its customers. The company operates four businesses: (i) John Crane (36%; energy focused sealing and filtration solutions ), (ii) Smiths Detection (26%; aviation focused security solutions), (iii) Flex-Tek (25%, construction focused liquid/gas management solutions) and (iv) Smiths Interconnect (13%; electronic components, sub-systems, optical and radio frequency products).
The group’s end-market exposure is General industrial 40%, Safety & Security 31%, Energy 22%, and Aerospace 7%. The regional exposure is Americas 54%, Europe 19%, Asia Pacific 16%, and Rest of the World 11%. Aftermarket sales generated over half (51%) the group’s revenues last year.
Strategy
MT demand underpinned by strong Megatrends and Aftermarket exposure. Smiths Group’s business model targets strong megatrends including (i) Decarbonisation and Green Re-Industrialisation, (ii) Ever-rising Security Needs and (iii) Rising Demand for Data. Aftermarket sales generated over half (51%) the group’s revenues last year, which provides resilience to the group’s earnings stream over the medium-term.
Material upside based on MT targets. While they look challenging based on recent performance, the group’s MT targets if achieved, represent significant upside. Furthermore, the new CEO’s approach towards M&A could fuel further inorganic growth and boost earnings momentum.
Financials and Targets
Recent Performance: Smiths Group has generated £3bn revenues with £500m operating profit (16.5% margin). £100m of other expenses and the group’s sub 1.0x leverage meant that PBT came in at £360m. The group’s EPS was 64p and management proposed a 42p dividend for the year.
MT Targets: The company aims to achieve 4-6% organic growth, 7-10% EPS growth, 18-20% operating margin and 100%+ cash conversion over the medium-term. The performance in the previous 5 year period does not inspire confidence and we view the targets as challenging.
Valuation
At 1780p, Smiths Group trades on 18x 2025E P/E (and 11.2x EV/EBIT) vs. long-term average of 15.6x, suggesting the market views the group as underperforming its potential and 2025 estimates to be 15% below the normalised level.
Concerns
An uninspiring performance in the last five year period raises questions on the group’s ability to deliver its MT targets.
New CEO needs to build a track record, particularly given his background of Smiths Detection which has underperformed the other divisions.
Management Incentives
CEO: Roland Carter was appointed in Mar 2024 following the resignation of previous CEO. He has grown within the company for more than three decades, holding numerous leadership roles including Smiths Detection President.
CFO: Clare Scherrer was appointed in Apr 2022 and joined from Goldman Sachs where she spent more than 25 years.
Annual Bonus: 200% of base salary based on performance on (i) revenues (40%), (ii) operating profit (30%), (iii) cash conversion (20%) and (iv) energy efficiency (10%).
LTIP: Upto 190k shares based on (i) Revenue growth (30%), (ii) EPS growth (20%), (iii) Average free cash-flow (20%), (iv) Average ROCE (15%) and (v) Absolute reduction in GHG (15%).
Financial Summary
