Wise up to Weir

We thought that in February, too. Strong results for 2011 plus long-term structural drivers and an undemanding rating convinced us the shares were worth more. Since then, however, oversupply of shale gas has driven US natural gas prices to a decade low, threatening the economic viability of some fields and Weir's profits.

That's bad news for the Glasgow-based firm. It makes lots of money supplying hard-wearing high pressure pumps and valves to companies extracting shale gas using so-called "fracking" technology. Yet the number of rigs drilling for natural gas in the US has fallen to a 10-year low, according to oil services firm Baker Hughes.

Still, there is a silver lining. Low gas prices, however unsustainable, have caused a rush to ramp up oil production, a much more profitable enterprise at over $100 a barrel. The US oil rig count hit a 25-year high recently, up 45 per cent year on year, and an increasing number of producers choosing to switch focus should help keep Weir busy.

Perhaps because the shares are easy to borrow, Weir stock has become a favourite among short sellers. But even they have begun to realise the game is up. Short-covering in anticipation of a reassuring first-quarter update on Wednesday 9 May has put a floor under the share price. Yet it should never have come to this. Less than a third of Weir's revenue (£743m), but 44 per cent of underlying operating profit (£183m), came from the oil & gas division last year, and even less from shale gas. In fact, minerals generated well over half group sales and profits. That's lower-margin stuff, but returns are tipped to stabilise at a respectable 17.6 per cent of sales.

City analysts value Weir shares at around 1,500p (or £3.2bn) without SPM, the major part of Weir's US fracking operation. Incredible, then, that SPM, which has an order book of around £280m and is expected to generate more than £616m of revenue, should only be worth £450m. Moreover, a larger installed base, following rapid growth in equipment sales, will lead to a larger proportion of revenue from less cyclical, and more lucrative, after-market activity, such as repairs, spare parts and services.

Besides, President Obama has earmarked shale development as key to US energy policy. The US Energy Information Administration predicts that by 2035 shale gas will account for about half of all US dry gas production – big business for Weir – but Poland, Argentina, Australia and China are also keen. Even Blackpool has a fledgling fracking industry.

That potential is not reflected in the current rating. In 2011, Weir shares traded on a forward PE ratio between 14 and 15. It's now just 11. True, earnings growth may slow to around 7 per cent from 2013, but such a big discount to international peers looks odd, given Weir's medium-term growth prospects and operating margins consistently in the high teens. Based on current forecasts, a return to 2011-style multiples would propel the shares to over 2,200p, quite possible once the outlook for oil & gas exploration becomes clearer.

Meanwhile, the launch of five new products, including new frac and slurry pumps, increases Weir's addressable market by more than $500m. That should generate extra sales this year, plus after-market business when parts need replacing.

And there's money to be made at the smaller power and industrial division. True, not much, but supplying valves, pumps and turbines to power plants and other industrial clients brought in £307m of revenue and a £27m profit last year. According to the City, a return to double-digit margins looks likely.