IMI's high-tech low-cost boost

It's taken many years, but at last the veteran industrial conglomerate IMI is looking like a lean and adaptable high-tech exporter. With UK growth likely to be sluggish, that's a strong position to be in just now. And even after a year of dramatic gains, IMI's share price doesn't reflect the good news - possibly because the company still hasn't completely shaken off its reputation for inefficiency. With even the most cautious City analyst pencilling in a 29 per cent leap in underlying earnings per share this year, it shouldn't be long before the market wakes up to the anomaly.

Most sales growth will come from IMI's cyclical Fluid Power division, whose pneumatic technology is used in products ranging from trucks to medical respirators. Because sales depend mostly on discretionary capital spending, this unit shrank 22 per cent last year. But the rebound - led by commercial vehicle sales - was so rapid that the company had to alert the market in a surprise trading statement in late April.

This was the second unscheduled update in six months. IMI stunned the market last November by announcing that its profits would far surpass expectations, thanks to a strict diet of staff cuts and offshoring, combined with lower commodity prices. It produced an operating profit margin of 15.3 per cent for the second half of 2009 - better than the previous record in 2008. That's quite an achievement so soon after a recession, but it's by no means the limit.

Although some costs will return with volumes, others won't. IMI has been gradually moving its manufacturing to places such as the Czech Republic and India since 2006. By 2012, half of all production should be low-cost. That bodes well for further margin progression, and more earnings upgrades as analysts take in the double impact of rebounding volumes combined with a shrinking cost base.

The recovery in Fluid Power is bound to slow in the second half, possibly significantly. In fact, the second half of 2010 could be weak as a whole, as IMI's other major divisions, Severe Service and Indoor Climate, depend on large contracts that held up well in 2009 but have slipped this year. Yet both these units are focused on growth sectors with high exposure to emerging markets, so 2011 should mark a return to form.

Severe Service, a world leader that makes vast bespoke valves for power stations and the oil and gas industry, is particularly compelling. Just how important this kind of device is has been evident during the BP debacle in the Gulf of Mexico. The expense of failure gives IMI significant pricing power, explaining the division's 19.8 per cent operating margin last year. The main opportunity for Severe Service now is in the 170 nuclear power stations slated for construction across the globe - a third of them in China.

One reason why IMI's shares are rated below the likes of Rotork and Spirax-Sarco - despite increasingly matching their margins and consistency - is that the group remains a conglomerate, with five largely unconnected units. The two smallest are particularly awkward fits, selling drink dispensers to McDonald's and retail display cases for cosmetics. Investors continually ask why IMI keeps these lower-margin divisions, and although management says it remains committed to them, Scott Cagehin, an analyst at brokerage Numis, thinks IMI would sell for the right price. That would make IMI a pure-play industrial engineer, which could spark a re-rating.