Smiths Group set for another bumpy year

Alongside a host of other issues, Smiths now finds itself in a position of management uncertainty. This month, chief executive Philip Bowman announced plans to retire at the end of 2015, joining the group's finance director, who is due to leave early this year. Given the lack of momentum over recent years a change in leadership could be seen as positive, but it also means that the widely discussed and required break-up will probably not occur until a new boss is installed.

When Mr Bowman joined Smiths in 2007 speculation was rife that his reputation as a dealmaker would spark a break-up of the five-division conglomerate. When we tipped Smiths off this potential and healthier end markets back in 2013, the chief admitted that he was keen to sell a division or two and refocus the group, yet issues including pension liabilities and asbestos litigation complicated things.

The value opportunity looks to have passed, too, now that the group's breadwinner of recent years, John Crane, is under threat from a falling oil price. Providing seals that help extract and transport oil and gas safely at extreme pressures and temperatures was in strong demand over the past decade as global demand for energy soared. But now, with oil supply continuing to outpace demand, the segment that accounted for almost one-third of group sales last year and 44 per cent of underlying profit looks likely to struggle due to expected cancellations and delays to projects. In fact, broker Panmure Gordon expects John Crane's sales to fall by 2 per cent in 2015 and a further 4 per cent a year in the following two years.

Smiths' other core divisions seem unlikely to pick up the slack. For example, its medical device business, which accounted for 30 per cent of profit last year, faces years of turmoil as the US healthcare industry adjusts to budgetary constraints and the Affordable Care Act (ACA). A gain in patient volumes and procedures as a result of ACA has not succeeded in offsetting the 2.3 per cent medical device tax paid by manufacturers such as Smiths, leading to ongoing volume and pricing pressures.

Elsewhere, Smiths Detection continues to battle with tight government budgets, a shift to larger contracts and increased competition. The US Budget Control Act of 2011, which sets out caps for spending through to 2021, means that investment in expensive, high-tech radars at ports and borders aren't likely to match post 9/11 levels for quite some time.

Given its net debt of £817m, a £242m pension deficit and £227m of gross asbestos provisions, the group also looks as though it lacks the financial flexibility to use acquisitions or major investment to reinvigorate prospects. What's more, Panmure Gordon reckons free cash flow will only average £200m between 2015 and 2017 compared with last year's dividend bill of £157m, which means fears of a cut could soon come into play, especially in light of the impending appointment of a new boss.