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FTSE 350 outlook - Electronics & electrical equipment

Created:

23 January 2008

Written by:

Tim Bradshaw

It would be easy to dismiss the electronics sector in light of global economic concerns. Indeed, share prices suggest that the market already has. But in spite of weakening consumer spending and the US slowdown, the UK electronics sector has several bright spots that investors are currently leaving in the dark.

Laird is a prime example. In spite of December's trading statement that pegged its 2007 results at the top end of analysts' expectations, with "exceptionally strong organic growth", investors apparently remain nervous about slower growth in the mobile handset market - forecasts suggest 10 per cent unit growth in 2008, slower than past rates of nearer 20 per cent. Similarly, shares in PV Crystalox Solar - a tip of the year for 2008 - actually fell on January's news that it would beat analysts' expectations for 2007.

Many electronics providers have high betas, and have suffered from the switch out of mid-caps in the last few months of 2007. Morgan Crucible was punished particularly harshly for December's trading statement, even though it confirmed that profits were in-line with market expectations. However, although it could be several months before sentiment improves, as analysts continue to downgrade their forecasts, a similar experience in 1999 suggests that when investors do warm to electronics stocks, the re-rating could be just as swift as the sell-off, says Evolution analyst Harry Philips.

Valuations were aided then by an "absolute explosion" in corporate activity, says Mr Philips. Indeed, takeovers such as MTL Instruments suggest that, as in the technology sector, corporate buyers are more optimistic about the outlook than investors. Invensys , for instance, is a lot smaller than many of its peers in the process automation market, in spite of its top-three position. And balance sheets have recovered since 2001, so most electrical engineers are unlikely to run into debt problems. A stronger dollar would also improve valuations.

That's why previously bearish analysts are now upgrading their recommendations - even as they downgrade forecasts. Goldman Sachs upgraded Halma for its "relative safety in uncertain times", while Landsbanki now says Morgan Crucible's share price fall is "overdone", providing an entry point to one of the sector's "higher quality groups". Spectris' January trading update revealed trading at the top end of expectations and margin improvements ahead of schedule. But Citi, in spite of upgrading from Hold to Buy, cut its Spectris earnings expectations for 2008 and 2009 by 8 per cent. That tension between forecasts, recommendations and broader sentiment will remain a feature of electronics for much of 2008.

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