Cookson steeled for recovery

Many UK investors have sought refuge from the chill winds of government austerity by buying shares in engineering groups, which tend to make most of their sales abroad. That has worked well so far; industrials shares, powered by the recovery in emerging markets, have topped the one-year price performance tables and there is no peak yet in sight. But it has also pumped up expectations and ratings, making buying into this story a riskier bet.

Yet there are exceptions, the most eye-catching being shares in Cookson. The steel products group dominates a global niche market with decent recovery prospects - all the things investors like about UK engineers - yet its shares still trade on a modest earnings multiple. Barring any nasty surprises in the company's third-quarter trading update, due to be published on November 11 after Investors Chronicle went to press, that looks unfair. Most recent global output indicators suggest growth is accelerating again.

True, there are reasons why Cookson's shares are lowly rated. The company saddled itself with debt to buy foundry business Foseco in April 2008, only to see its profits collapse in the recession. By the time it pushed through an emergency rights issue to refinance the deal in March 2009, its share price had fallen by over 90 per cent.

It still has £405m of net debt, but that looks less crippling now that pre-tax profits for 2010 should come in around £200m. Investors also worry about Cookson's exposure to the infamously volatile steel cycle. Global steel leader ArcelorMittal recently warned that its profits would slip as rising iron-ore prices could not be passed on to customers.

Yet Cookson makes consumable products that are used in steel production - ceramic furnace linings and so-called flow-control devices, such as plugs and stoppers. That means it's more exposed to production volumes and furnace capacity than to steel prices. The World Steel Association currently forecasts 5.3 per cent volume growth next year, thanks largely to frenetic infrastructure construction in emerging economies. And even if the dreaded double-dip recession does materialise, Cookson's sales would not evaporate at the same rate as last year because its cash-conscious clients are now operating at much lower inventory levels.

Besides, steel production is only half the picture. Foseco, whose foundry moulds and filters are essential for casting car and truck parts, has brought Cookson a whole new set of industrial markets. These recovered later than steel production, starting in emerging markets early this year and reaching Europe and North America in the summer, according to Cookson's half-year results. Yet now that Foseco's recovery is under way the group should enjoy an extra growth kick well into 2011 even as steel production moderates.

Cookson also has two smaller divisions, the larger of which, electronics, mainly sells specialist solders for assembling circuit boards. This business took a hit in the early stages of the recession, but sales have been improving since mid- 2009 and forecasters expect high single-digit growth in 2011. Profit margins may fall because surging tin and silver prices will inflate sales revenues (Cookson passes these higher costs straight through to customers), but that won't affect underlying profitability.

True, the imbalance of businesses within the group is a flaw. The ceramics division became so large with the Foseco acquisition that it now dwarfs electronics, let alone the insignificant precious metals division, which Cookson has long wanted to hive off to a more suitable parent. It's hard to know how management will address this problem, as shareholders are unlikely to stomach the scale of acquisition that would bolster electronics into a meaningful second leg until debt is significantly reduced. And Cookson will have to wait until more stable times to sell its precious metals side.