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High-yielding Vesuvius ready to recover

The molten-metal-flow engineer's high-yielding shares could soon re-rate once the full benefits of anti-dumping tariffs in core markets and self-help become apparent
June 9, 2016

The global steel market has made the headlines for all the wrong reasons lately. Not only has global economic uncertainty and China's transition away from infrastructure investment led to plummeting demand, but the People's Republic has been flooding the market with surplus steel at rock-bottom prices, exacerbating this downturn. While this rampant overcapacity recently sent Europe's second-largest producer, Tata Steel, into meltdown, other recent developments suggest that the cycle could soon be turning. As a leading provider of pipes, valves and furnace linings to the sector, Vesuvius (VSVS) looks well-placed to benefit, and its shares offer a high yield to sustain investors as they wait for a recovery driven re-rating.

IC TIP: Buy at 332p
Tip style
Income
Risk rating
Medium
Timescale
Long Term
Bull points
  • Anti-dumping tariffs boosting demand in core markets
  • 4.9 per cent dividend yield
  • Self help cost savings
  • Director buying shares
Bear points
  • Dependent on volumes in cyclical industries
  • Chinese overcapacity

The world's biggest steelmaker ArcelorMittal recently revealed that it expects global demand to stabilise in the year ahead. Its forecasts have been backed by international trade body the World Steel Association, which predicts consumption to grow everywhere but China next year. Driving this optimism is the imposition of restrictions on cheap Chinese imports that have been put in place in North America and more recently by countries such as Europe and Australia. Indeed, since the US first introduced anti-dumping tariffs, the value of steel there has surged 50 per cent.

 

 

Although China is still responsible for driving global steel production, North America and Europe are much bigger consumers of Vesuvius's high-value consumable products. Whereas the People's Republic tends to specialise in the low quality production of bars for building projects, other more developed regions use the metal in industries where the finish must be perfect. High-resistance flat steel pressed for cars, pipes and packaging is worth three times as much for Versuvius as the typical work that comes out of China. This helps explain why just 8 per cent of group revenues are generated in China, and why the net result of anti-dumping tariffs could be a significant recovery in the molten-metal-flow engineer's profits.

Vesuvius's status as the premier provider of consumables used in foundries for casting, iron, steel and materials suggest it's likely to be an immediate beneficiary of any upturn as the industry restocks in anticipation of rising demand. The group's ceramic components are fundamental to the production process and help to prevent waste, which in times of economic uncertainty remains a pressing concern.

This enviable niche market position, coupled with a supportive dose of self-help (£8.8m of annual savings were made in 2015 and this is expected to rise to £20m by the end of next year), helps to explain why the engineer is surviving the downturn better than peers. Immediate efforts to adapt the cost base and focus on higher-margin value-added solutions offset more than half the estimated gross profit impact caused by volatile markets in the year to 31 December 2015.

Importantly, these measures should help preserve the attractive dividend. In the previous financial year, free cash flow of £59.1m - helped by falling capital expenditure and working capital requirements - easily covered the £43.9m paid out to shareholders. Now that the group has renegotiated its revolving credit facility on better terms until 2022, analysts are in reasonably broad agreement that the dividend can be maintained.

While retaining a strong balance sheet remains a key focal point, the acquisition of companies operating in growth markets is also a priority. Lately the group has been busy expanding its presence in emerging markets such as China, India and South America, where the long-term trend of rising middle classes is expected to shift economies from being investment to consumption-led, causing increased demand for the engineer's higher-margin products used in applications such as packaging and consumer durables.

 

VESUVIUS (VSVS)
ORD PRICE:332pMARKET VALUE:£900m
TOUCH:331-333p12-MONTHHIGH:448pLOW: 265p
FORWARD DIVIDEND YIELD:4.9%FORWARD PE RATIO:12
NET ASSET VALUE:322p*NET DEBT:32%

Year to 31 DecTurnover (£bn)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
20131.51125.231.815.0
20141.44127.833.316.1
20151.32108.628.016.3
2016**1.2692.723.916.3
2017**1.30105.127.116.3
% change+3+13+13 -

Normal market size: 1,500

Matched bargain trading

Beta: 0.92

*Includes intangible assets of £684m, or 252p a share

**Panmure Gordon forecasts, adjusted PTP and EPS figures