Fighting fit

To some extent, the same theory can be applied to those countless cyclical companies under pressure to generate value in times of sluggish economic growth. When end markets are affected by weak consumer spending in nations ravaged by recession this is no easy task, although simply withstanding losses while waiting for the economic cycle to turn is no way to appease impatient investors.

The collapse of the global economy in 2008 wiped billions of pounds off the value of companies, yet damage control measures have since been implemented by those companies to squeeze profits from the many regions still to return to pre-recession form. With cuts to GDP forecasts still lingering some seven years later, it is perhaps no surprise to see so many analysts put so-called ‘self-help’ stocks highest on their 2015 shopping lists.

As the phrase suggests, self-help is about finding ways to generate growth internally when companies are exposed to markets where the odds are stacked against them. These restructuring initiatives can take on a variety of forms, and essentially define the reputations of managerial teams across the country.

There are plenty of self-help strategies that fail to trickle into the bottom line, though - especially when management leaves the restructuring measures too late, cuts too far, or in the wrong places. But there are also several examples of restructuring initiatives significantly boosting margins and earnings. Better still, because of the bearish sentiment surrounding cyclical stocks in periods of macroeconomic uncertainty, the potential uplift that accompanies these resuscitating measures aren’t always reflected in valuations.

Clearing the deck

In most cases, simply being more stringent with assets can yield impressive results. Several industrial companies with exposure to weaker regions like Europe, for instance, have been adopting cost cutting measures such as closing down facilities and reducing staff numbers to boost margins.

Take chains and gearbox maker Renold (RNO), for example. Despite low growth in its markets and fierce currency headwinds, cost savings helped the group increase underlying pre-tax profits by over two-thirds to £7.5m in the six months leading up to 30 September 2014.

Chain reaction: A strategic review at Renold led to 200 job losses, but £3.2m in additional profit

A key ingredient of this success, and a 3.3 percentage point increase in operating margins to 8.3 per cent, was the closure of its lossmaking Bredbury facility. Following a strategic review on how to improve the business, the plant in Stockport was declared not economically viable, resulting in 200 job losses but £3.2m of additional annual profit.

This type of aggressive approach is central to chief executive Rob Purcell’s aim to mastermind a turnaround in the group’s fortunes. Mr Purcell, who joined in January 2013 from plastic products manufacturer Filtrona, immediately sought to merge three UK defined benefit pension schemes, cut cash funding costs by £1.6m to £4.2m and achieve double-digit adjusted operating profits. The success of this tactic turned us into buyers last May (53p, 1 May 2014), with shares in the manufacturer of products used in tube escalators and Big Ben’s clock tower since rising 13 per cent.

True captains

Coincidentally, the chief executive of Mr Purcell’s former employer has had a similarly big impact. Since Colin Day took the reins in 2011, Filtrona – now known as Essentra (ESNT) – has been revolutionised from a sluggish cigarette filters maker into a scintillating growth story.

Mr Day’s five-year plan to reach FTSE 100 status may seem far-fetched, but one look at the progress he’s made so far suggests the supplier of speciality components now has the right foundations in place to achieve it. Under his command, a change in culture was introduced that centred on growing the product range, aggressively cutting costs and acquiring businesses in markets underpinned by structural drivers.

This approach has nearly quadrupled Essentra’s market cap and seen revenues and pre-tax profits almost double. We recently turned buyers on the back of this self-help-driven momentum (901p, 26 Feb 2015).

A similar turnaround occurred when Leo Quinn took the reins at Qinetiq (QQ.) in November 2009. At that time, shares in the defence contractor (pictured, below) had been hit hard by the withdrawal of troops from Afghanistan and Iraq, having more than halved from their flotation price of 200p in 2006.

Defending its position: Mr Quinn transformed £540m debt into £205m net cash within 5 years

But under Mr Quinn, who has since left the group to work his magic at struggling infrastructure giant Balfour Beatty (BBY), a five-year restructuring plan was implemented to revamp the company’s culture and change its university-like mindset. Building on Qinetiq’s reputation as a research arm that invents and develops high-tech products for the government, he was keen to branch out into new markets in a bid to generate higher profits.

To do this, he replaced 80 per cent of the company’s leadership, cut the workforce, reduced its civil-service-style redundancy terms and sold the group's lossmaking US services division, all of which helped transform a debt pile of £540m into net cash of £205m within five years.

With a much healthier balance sheet and more commercial focus, Qinetiq became better-equipped to survive an era of tepid defence spending. Mr Quinn, meanwhile, evolved into something of a cult figure in the Square Mile – when he announced his intention to leave, the shares tumbled almost 12 per cent.

That sentiment hasn’t improved much over the past few months either, as speculation that UK defence budgets will be cut even further after the election in May continues to strike fear into investors. But, irrespective of this gloomy outlook, higher-margin niche offerings and growing Middle East demand should serve a leaner and fitter Qinetiq well in the longer term: after a forecast 10 per cent earnings dip this year, profits are expected to rise steadily.

Sentiment in TT Electronics (TTG) has been similarly rocky of late. Despite introducing cost-cutting plans to generate growth, the electronics firm lost almost a third of its value after warning that full-year profits will be lower than predicted over the next few years.

This came after unions delayed plans to move to cheaper territories – having successfully transferred product lines from California to Mexico, a similar shift from Germany to Romania was held up. Nonetheless, this move should eventually go through and further boost a cost-saving programme that helped operating profits grow almost fourfold to £3.7m at the halfway point of 2014.

Plugging the leaks

Cost-savings have also been successful in propping up weaker units within a business. This has certainly been the case at Connect Group (CNCT), whose flagship news distribution segment managed to post a 7 per cent rise in underlying operating profits to £42.9m in a declining market. Cost-cutting measures were cited as the reason behind this surprising turnaround, with the same approach now being applied to resurrect its floundering books unit.

Investors will be hoping these measures keep Connect intact during its transitional phase into new growth sectors, including a click-and-collect delivery service linking Amazon with thousands of independent retailers. Based on its exciting growth strategy, high dividend yield and strong management of segments in declining markets, we turned buyers last year (166p, 20 Nov 2014) and have every faith that the company, formerly known as Smiths News, will deliver on its potential. Its distant relative WH Smith (SMWH) has already demonstrated that cost savings can be eked out for years.

It has been a similar story for our old and reliable tip of the year, Hill & Smith (HILS) (577p, 8 Jan 2015). While its infrastructure products are increasingly popular in both the UK and US, management has had its work cut out to protect its core utilities division. This part of the business typically brings in the largest revenues and lowest profits, as products such as plastic pipes for flood alleviation don't command massive margins. Self-help measures, however, have eased utilities’ dependency on GDP growth and helped it keep apace with the group’s more attractive prospects.

Hill & Smith's infrastructure products are increasingly popular in the UK

Sail on

But not all companies are keen to resuscitate struggling businesses. As previously mentioned, one of the strategies Leo Quinn adopted to resurrect Qinetiq’s fortunes was to get rid of the defence contractor’s lossmaking US services division. Stringent defence budget cuts ruled out hope of a turnaround here, so much so that the group wrote down £256m of the arm’s value.

Nevertheless, in tough trading environments it’s sometimes best to cut your losses and focus on core strength areas. This is the strategy adopted by SIG (SHI), the insulation and roofing materials specialist that has been struggling with the fact that over half of its revenues are generated in troubled Europe.

Through the downturn, management sought to identify cost synergies and dispose of underperforming assets, such as the German roofing business. This particular unit had been struggling with poor weather conditions, yet was still sold off for a net gain of £7.2m. Elsewhere, management’s tight hold on purse strings generated annualised cost savings of £7.9m, leaving the group in far better shape to weather the ongoing storms of weak trading on the continent.

Morgan Advanced Materials (MGAM), too, has been impressing investors with its selling off of low-margin units. At 339p, shares are up 17 per cent on our buy tip (289p, 19 Dec 2013), thanks to a revolutionary programme initiated to bump up margins in the face of subdued global industrial growth.

Under the direction of chief executive Mark Robertshaw, who has since been poached by Innovia, the manufacturer of carbon and ceramic products used in artificial hips and triggers for rocket launchers introduced a project designed to unify the various group businesses. This process also involved cost-cutting, focusing on growth markets such as aerospace, healthcare and emission control and ridding itself of low-margin divisions.

For Mr Robertshaw the goal was to transform Morgan into a high-tech, high-margin engineering powerhouse by veering away from its commodity operations that the “Indians and Chinese can do… at a lower price”. “If it isn’t rocket science, we don’t want to do it”, he famously quipped.

Needless to say, the business has continued to focus on diversifying into growth areas since Mr Robertshaw’s departure, evidenced by the appointment of Cobham’s communications and connectivity president as his replacement. Given Pete Raby’s background in technology-led innovation, this move appears to line up nicely with the group’s metamorphosis into a high-tech engineer.

Cobham (COB), meanwhile, continues to exceed expectations in a sector plagued by shrinking defence budgets. Shares in the defence contractor rocketed after a positive trading statement in November revealed decent order momentum and the ongoing success of its cost-cutting programme.

But while integrating and rationalising sites, among other things, has helped the group close in on its target of £100m of savings by 2016, it's bolt-on acquisitions that have really been driving the top-line. By diversifying into areas such as marine satellite communication and recreational aviation, Cobham now generates over a third of sales from non-defence customers.

On target: Cobham is closing in on its target of £100m in savings by 2016

In 2014 that shift in focus drove order intake up two-fifths and sales up by 9 per cent. But, on the flip side, new work commands lower margins than land warfare products, hence why the group still impatiently waits for the Pentagon to fork out big bucks again, while enjoying the rise of political unrest in eastern Europe and the Middle East.

Bolt-on acquisitions also form a key part of Mark Selway’s strategy to reinvigorate IMI’s (IMI) fortunes. Having joined the engineer from Weir (WEIR) at the beginning of last year, the man dubbed as "Mr Fixit" immediately excited investors with an ambitious vision to double operating profit by 2019.

Organic growth is expected to be achieved by expanding IMI’s product range through bolt on acquisitions, and by upping spend on research and development to ensure existing products are among the best in the market.

Sadly for Mr Selway, a falling oil price has since threatened the viability of these ambitions, as its critical engineering segment feels the bite of reductions in capital spending by the oil majors. Still, shares have been resilient in the face of this worrying news, which goes to show the level of confidence that IMI’s latest chief executive has evoked in investors.

The right tools for the job

IMI’s ploy to invest more money in areas where it excels is proving to be a popular strategy to counteract increasingly competitive end markets. Indeed, even those selling into cyclical markets have reported record order books in the previous year, simply because their products stand out from the rest.

Nuts and bolts: Trifast has tapped into the supply chain consolidation trend

Trifast (TRI), pictured above, whose shares are already up 12 per cent on our recent buy tip (95p, 22 Jan 2015), is just one example of this successful formula. When chief executive Jim Barker joined the manufacturer of mechanical fasteners in 2009, an overdependency on sales to electronics manufacturers and their distributors saw the company hit a brick wall.

That all changed, though, under Mr Barker’s leadership. Aside from branching out into new markets underpinned by structural drivers, a key component of Trifast’s recent success stems from catering to the supply chain consolidation trend favoured by cash-rich multinational original equipment manufacturers. Tough trading conditions have swelled the number of clients demanding delivery and support of standardised products at a global level, helping Trifast stand out from the rest, secure more blue-chip customers and subsequently post its strongest ever order pipeline in November.

Likewise, Scapa (SCPA) has undergone a remarkable corporate turnaround story since Heejae Chae was appointed chief executive in 2009. A huge overhaul saw the manufacturer of adhesive tapes and films reduce its exposure to low-margin commodity tapes in favour of branded goods and application-specific offerings. Recent results indicate the continued success of that shift in focus, with an 80 basis point increase in margins at the half-year mark translating into a 15 per cent increase in trading profits to £8.5m.

Those who followed our buy advice when Mr Chae’s magic started kicking (48p, 11 Nov 2011) were richly rewarded – the shares rose 181 per cent on our well-timed call. Yet while management’s efforts to reduce the cyclicality of Scapa continue to bear fruit, an expensive rating of 16 times 2015 earnings suggests those prospects are now priced in.

Elsewhere, we have been keeping a very close eye on developments at Acal (ACL), Gooch & Housego (GHH) and Johnson Matthey (JMAT). A self-help story centred on moving up the value chain in specialist electronics distribution has prompted a successful run for shares in technology group Acal. Selling higher value goods has seen EPS grow at double the rate of peers, despite heavy exposure to Europe.

Shares in optical components specialist Gooch & Housego, meanwhile, have been boosted by management’s drive to increase exposure to higher-growth markets like aerospace and life sciences. Moreover, having already grown margins through cost-cutting measures, chief executive Gareth Jones sought to move the Aim-traded group up the value chain by supplying easier to install integrated subsystems.

Like Acal, however, the potential of a fitter and leaner Gooch is already reflected in its rating of 19 times 2015 earnings. This is similarly the case for Johnson Matthey, whose shares also trade on a forward PE ratio of 19 after a lengthy period of success for its catalyst segment.

Stricter legislation for fuel efficiency means manufacturing catalytic converters is big business for the chemical giant. But recent growing anti-diesel sentiment could put a strain on this momentum, as could the adverse effect a lower oil price is having on its process technologies unit.

Making life easier

As the likes of Trifast, Acal, and Gooch & Housego have proved, a successful self-help strategy isn’t just about acquisitions and stringent cost-cutting. Indeed, plenty of companies in cyclical sectors have been able to weather the storm of sluggish economic growth simply by homing in on customer needs.

That has certainly been the case for DS Smith (SMDS), the packaging business that makes two-thirds of profits in the troubled eurozone. By introducing other packaging and logistic services to clients, the group has ramped up the scale of services it offers to compensate for rising competition.

Making a packet: Demand shows no signs of faltering at DS Smith

It seems to have had the desired effect, too. In spite of eurozone deflation worries, volumes of its corrugated packaging rose by 2.3 per cent in the six months leading to November 2014. Demand shows no signs of faltering either, as evidenced by a recently signed five-year contract to become sole supplier to international food company Mondelez. This progress, coupled with effective cost saving measures to offset higher paper prices, has driven shares up 126 per cent since we tipped it back in 2012 (167p, 23 Feb 2012).

Brammer (BRAM), too, has responded to a prolonged downturn on the continent by simply offering key customers more. Installing industrial tool vending machines and rolling out its popular Insite model – described by the group as like "having a Brammer branch in your plant" – helped the distributor of maintenance, repair and overhaul products recently secure 14 contracts worth more than €60m (£44.6m) a year.

A heightened focus on customer relationships has also been easing Croda (CRDA) and Vesuvius (VSVS) through tough markets. The former responded to rumours that customers in Europe were sourcing cheaper ingredients by attempting to better understand their needs, while the latter, dogged by lower-margins in the iron and steel sector, replied by innovating its product line with input from customers.

As e2v’s (E2V) chief executive would say, when manufacturing technical products it's fundamental not to alienate customers or investors. Steve Blair, who joined the niche electronics company in March last year from Spectris (SXS), instantly set out to make what e2v does more straightforward to understand as part of his plans to revitalise the misunderstood company’s fortunes.

Under his leadership, the manufacturer famous for supplying the camera systems used to capture images of Rosetta's space journey plans to remove the shackles of its conglomerate past via its 'bringing life to technology' programme. Centred on customer responsiveness, innovation and operational excellence, so far this fresh approach has already helped generate growing sales in its exciting end markets.

Confidence in the company has received a massive boost, too, with shares up 18 per cent since we turned bullish at the end of last year (170p, 4 Dec 2014). Like several of his peers listed here, the new man in charge at e2v has developed a cult following with analysts, and could well reach Winston Churchill status among shareholders in the years to come.