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Be wary of Weir

Shares in the Scottish pump manufacturer trade at a premium to their historic average despite a fast deteriorating outlook.
October 23, 2014

Weir Group (WEIR), the Scottish supplier of equipment to the mining, oil and gas, and power industries, suddenly does not look so attractive. For much of 2014 its share price has been underpinned by buoyant demand from the oil and gas market for the engineer's pumps and specialist drilling equipment, which has helped compensate for weak demand from miners. Yet we believe the oil and gas industry looks set to put the brakes on capital expenditure following the recent bout of extreme oil-price volatility. Indeed, brokers have already begun to downgrade their earnings predictions for Weir in response to oil price ructions. But despite the recent turmoil, Weir's shares don't look cheap. In fact, priced at nearly 15 times next-twelve-months consensus forecast earnings, the rating is above its five-year average of 14 times despite the mounting uncertainty about end markets and the potential impact on Weir's margins and sales.

IC TIP: Sell at 2208p
Tip style
Growth
Risk rating
High
Timescale
Long Term
Bull points
  • Trio acquisition will boost revenues
  • US dollar headwinds subsiding
Bear points
  • Oil price volatility
  • US shale boom under threat
  • Mining pricing pressures continue
  • Shares rating above five-year average

At a capital markets day in June, Weir said it was targeting organic growth of between 5 per cent and 10 per cent over the cycle for its buoyant, high-margin oil and gas business. Since that point, however, the cost of a barrel of Brent crude has tumbled 22 per cent, as a steady decline in Asian demand, combined with growing supply surplus, has driven prices to a four-year low. And even if prices recover, the uncertainty created by such marked falls is likely to weigh heavily on the industry's spending decisions for some time.

 

 

This could prove particularly painful for Weir. Indeed, in the first half continued strong growth in demand from the US shale industry was particularly helpful in offsetting weak mining demand. Yet with oil prices crashing, concern has spread that higher-cost shale operations, many of which are heavily in debt, will struggle to raise funds and maintain drilling activity, which could hit high-margin sales hard.

Meanwhile, the outlook for the mining division looks uninspiring. Commodity prices continue to weaken, bringing capital expenditure down even further as the mining majors like Rio Tinto and BHP Billiton target cost-cutting measures. Under pressure to deliver dividends in difficult markets, these players are seeking to squeeze costs out of servicing and maintenance.

It's not all bad news for Weir, though. The group no longer has to sweat over the implications of the Scottish referendum, the recent strength of the US dollar against sterling is a help and its $220m (£138m) acquisition of Trio Engineered Products looks like a good deal that will help it better compete with Finnish rival Metso. Although the mining sector has been dogged with problems, Trio has grown strongly in the subdued market. Nonetheless, any positives to take from this deal, together with resilience provided by the aftermarket revenue from already-installed equipment, are being overshadowed by a weakening global economic outlook that has left Weir’s end markets in dangerous territory.

We don't think the shares have yet fully factored in the risks and the market's view of Weir may still be clouded by the summer distractions of an unsuccessful bid for Metso and rumours of merger interest with IMI. But the downgrades have already started. Before news of the Trio deal, broker Investec cut underlying EPS forecasts by 2.5 per cent for this year and 3.9 per cent for 2015, although the acquisition has prompted a 1.6 per cent upgrade to the reduced 2015 forecast. Panmure Gordon meanwhile was predciting that Weir’s oil and gas business would be lucky to grow at all in 2015 prior to the Trio deal.

WEIR GROUP (WEIR)
ORD PRICE:2,208pMARKET VALUE:£4.7bn
TOUCH:2,207-2,209p12-MONTH HIGH:2,848pLOW: 2,036p
FORWARD DIVIDEND YIELD:2.3%FORWARD PE RATIO:15
NET ASSET VALUE:687p*NET DEBT:51%
**Includes intangible assets of £1.5bn, or 722p a share

Year to 31 DecTurnover (£bn)Pre-tax profit (£m)Earnings per share (p)**Dividend per share (p)**
20112.2939613433
20122.5445615538
20132.4341814542
2014**2.3940413846
2015**2.5443914950
% change+6%+9%+9%+9%

*Panmure Gordon forecasts

**InvestecSecurities forecast adjusted PTP and EPS figures

Normal market size:750

Matched bargain trading

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