Give Smiths a break

Big acquisitive conglomerates such as Hanson and BTR are history and the days of their modern day equivalents may be numbered. Certainly, speculation that one of Smiths' divisions may be jettisoned is never far away.

It's obvious why. Chief executive Philip Bowman took over in 2007 having already sold both Scottish Power and Allied Domecq. Smiths might have gone the same way, too, had it not been for the credit crunch. Mr Bowman admitted as much to US investors last summer. Smiths' portfolio had "limited strategic rationale," he told them, adding that poor markets had "not been conducive to optimising value creation through disposals". One day they will be.

Is it worth the wait? Yes. Remember, Smiths turned down a £2.45bn approach for its medical division from Apax in January 2011. Things have gone quiet, but trade buyers in the US, like Baxter Healthcare and Covidien, would still love to own it. And 80 per cent of sales are disposable devices, which constantly need replacing, meaning earnings are secure. Over half its sales are already made in the US, too. True, it will struggle for growth this year, but profit margins are near the top of the 20-24 per cent target range and organic revenue is tipped to add at least 3 per cent to sales next year.

That said, selling the medical side would remove Smiths' second biggest revenue source and major cash generator. And, of course, one benefit of conglomerates is the protection afforded by diversity. Medical and John Crane, a supplier of mechanical seals to oil companies, are the least cyclical operations and make almost two-thirds of group sales and most of the operating profit. As such, they sit at the heart of the group and, crucially, of the company's credit rating. So any sale must achieve a knockout price. Detection, too, could be worth much more if US airports like its new high-speed explosive detection system.

How much then? One City analyst believes £3bn would prise medical from Mr Bowman's grasp. That kind of money would also deal with the complicated issue of pension liabilities, long seen as a stumbling block to a break-up.

Ask analysts at Credit Suisse and they'll say Smiths' sum-of-the-parts value is about 1,400p, using earnings multiples paid for similar businesses. This gives some idea of the "conglomerate discount" that encumbers Smiths. The snag is the earnings multiples are historic. "All are moveable feasts and depend very much on your forecasts and the last transaction in that sector," cautions a rival analyst with a break-up figure of nearly 1,500p.

Big disposals don't happen very often either and often rely on luck. It's vital, then, that Smiths is more than just a break-up story. Cost-cutting and building emerging market exposure were also among Mr Bowman's remits, and he has had success on both fronts.

Restructuring has already delivered £49m of cost savings and another £20m should be in the bag by the end of 2013. Add in £40m from work ongoing at the detection unit and Smiths should be saving £110m a year in 2014, the equivalent of seven percentage points on its profit margins, according to Credit Suisse. And Smiths is winning share in more dynamic emerging markets. Sales there were up a quarter in the first half - India jumped 40 per cent and Latin America 11 per cent - and now account for 15 per cent of all revenue.

Third-quarter numbers for 2011-12 were reassuring, too. John Crane did well and growth in emerging markets at detection will help offset the impact of lower government spending in the west. Demand from Boeing and Airbus for high-tech hoses is driving sales at Flex-Tek, a business highly geared to recovery in US housebuilding. Military cuts, meanwhile, are hampering progress at Interconnect, offsetting sales of connectors used in smartphones and tablet devices.