The five recovery plays

Aero Inventory

I am including this as a somewhat risky recovery share, the success of whose future business is closely tied to the fortunes of the world aerospace industry. The group provides procurement and inventory management services concentrating on aerospace parts with customers spread widely around the globe including Australia, Canada, Japan, China, Indonesia, Switzerland and the UK.

Aero Inventory has achieved rapid growth in sales and profits over the past five years, with sales rising from £21m in 2004 to £221m for the year ended 3o June 2008. Over the same period operating profits rose even more dramatically, from £1.9m to £46.9m, and EPS from 5.2p to 51.1p. At one stage in late 2007 the shares reached 700p but have fallen back substantially over the past year and now trade below 200p. Investors clearly fear that Aero Inventory will suffer badly as its airline customers cut back on outsourced services in the sector's present disastrous trading environment. However, the analysts who follow this company believe that management will be able to continue to grow the business and are forecasting EPS of around 70p for 2009 and 77p for 2010. Such progress would rate the shares on a derisory price-to-earnings (PE) ratio of a little over two times, which seems ridiculously low.

Hamworthy

As a supplier of products and systems for the marine and oil & gas industries, this successful company has suffered with the market downturn compounded by falls in both shipping rates and the price of crude oil.

The company's trading record over the past five years is excellent, with sales climbing steadily each year from £91m in 2004 to £253m in the year to end-March 2009. The latest preliminary results, which were announced on 2 June, show that a 9 per cent increase in total sales translated into a 42 per cent rise in operating profits, as gross margins were pushed up from 7 per cent in 2008 to just over 9 per cent in the year just ended. EPS for 2009 is reported to be 40p, a trifle above analysts' forecast of 37p, while the final dividend of 5.68p makes a total payment for the year of 8.73p.

These figures pleased the market and the shares rose sharply even though the final outcome for 2010 is likely to be adversely affected by weakness in the closing order book, with total orders on the books at the end of the year some 16 per cent lower than at the same time last year. Thus, even though the medium-term trading outlook is somewhat uncertain, the longer-term potential appears encouraging as the acquisition of new businesses is greatly reducing the dependency on shipping orders while growing environmental legislation will boost demand for Hamworthy’s services. Additionally, the group is tightening operational efficiency and is striving for higher margins and greater output from a further streamlined workforce.

Hamworthy has a strong balance sheet, too – at end-March 2009 net funds had risen to £55m. It also has a positive dividend policy. Even though the shares, at 230p, have risen by more than 10 per cent since the publication of the latest results, they appear an attractive medium-term investment on a PE ratio of 5.8 and a dividend yield of just under 4 per cent. They look an interesting play on a gradual recovery in international trade, especially as oil prices are now starting to rise quite strongly again.

Meggitt

Meggitt has a great record of growth in both sales and profits over the past five years, with sales having risen from £477m in 2004 to £1,163m in the year to end-December 2008, although profits have not risen quite as strongly. As a high technology company supplying products and systems to the global aerospace industry, Meggitt is somewhat vulnerable to the problems in that sector and also to pressures in the defence sector as its products and systems are bought by leading air forces. In fact, it was announced early this year that the US air force had awarded a US subsidiary a significant follow-on contract for a large fuel tank order. Last month Meggitt also reported an order worth £150m for its NuCarb braking system for Bombardier feeder planes.

Yet, despite the good trading record and the low valuation, investors are concerned whether the group will be able to maintain its growth. However, given the fall in the share price from the past trading levels of over 300p, it seems the present price level exaggerates the dangers. So I have included the shares in my selection at the price of 160p at which they are selling on a forward PE ratio of 6.3 and on a dividend yield of 5.3 per cent.

Melrose

In the engineering sector Melrose came near the top of the Star selection list in January this year and looked attractive at that time. I believe it still does, although the share price has risen from 70p at the start of the year to the current level of around 106p.

The company was set up to acquire quoted manufacturing businesses that were in need of a major profitable re-vamp. It is headed by chairman James Miller and chief executive David Roper and run by experienced industry managers. Melrose started life by buying two specialist engineering companies, Dynacast and McKechnie, in May 2005 for £429m. Melrose then sold a large part of McKechnie for more than the original acquisition price for both businesses in July 2007. The group's next action was to buy FKI in July 2008 for £970m. FKI is a leading listed engineering group that specialises in lifting products and services as well as energy technology products and automated logistic solutions.

Melrose's last financial year ended in December 2008 and the group announced satisfactory results for the year in March, which included the purchase of FKI. In a statement in March the chairman was upbeat on the potential for increasing cash returns from the FKI businesses which cover power generation, the oil & gas sectors and healthcare. The team has been successful in generating cash from disposals of unwanted assets and is positive about the outlook for further profits growth from the underlying businesses.

One of the main worries that concern potential investors in Melrose is the level of debt that is owed by the group as, at 67 per cent, this is above average for the sector. However, Melrose appears able to pay down some of this debt and announced at the end of May that it had sold FKI Logistex Holdings for $40m (£25m). Evolution Securities, one of the stockbrokers covering the group, recently upgraded the shares to a 'buy' on basis of their cheapness relative to their peers and gave them a target price of 140p.

XP Power

For many years I have had a small shareholding in XP Power, a specialist electronics component supplier. The company is a manufacturer and supplier of power control solutions to the electronics industry and particularly to the industrial, technology and healthcare sectors. I have to say that over the years XP Power has not been a profitable investment for me. Still, during the past few months the company's share price has started to recover and the outlook appears brighter than for many years. At their current price of around 200p, the shares could be a good medium-term investment.

The company, whose shares have been quoted on the London Stock Exchange main market since 2000, is now based in Singapore and has manufacturing facilities in China. It sells a significant proportion of its output in the US and issued a positive trading update on 15 May 2009 for the first four months of the financial year to end-December 2009. This announcement indicated that trading had been satisfactory and that expectations for the year should be met. The company is looking to increase in its own intellectual property revenues from a new Chinese manufacturing plant that will come on-stream very shortly. XP Power believes that the output from this unit will improve the margins and overall profitability of the group. It also claims to have developed a range of smaller, more environmentally-friendly power control products.

On the negative tack the company is fairly small with a market capitalisation of only £40m, has recently arranged a debt facility of $36m which represents a significant, though manageable, level of debt while the executive chairman has pledged 2.5m shares (13 per cent of the issued equity) as security for a personal loan for the purchase of XP Power shares. Despite these caveats, XP Power is a much overlooked share that has the potential to advance further as market conditions improve.

At the current price of around 200p the shares are selling on an undemanding prospective PE ratio for the current year of 5.7 while also returning a highly attractive dividend yield of around 10 per cent. With a wide spread of products and customers both globally and by sector, XP Power appears to be on a sustained recovery path. The latest quarterly results, which were announced last month, indicated that the group was performing in line with expectations

An added positive feature is the group's move into the Far East, with output from its Chinese facilities expected to boost revenues in the current trading period. And the prospect of rising fee income from XP Power's intellectual property rights is another potential bonus.

Key statistics

Source: John Mulligan