FTSE 350 Review: Plenty of heat but not much light for industrials

There were promising spots, including Coats (COA) – whose share price only fell by 4 per cent, and which was our favourite in last year’s review. It comfortably outperformed the 25 per cent decline in the benchmark. By contrast, our outsider, Spirax Sarco Engineering (SPX), declined by 34 per cent.

For most manufacturers, the past year has been a battle to keep costs in check, or at least to pass on increases as quickly as possible to customers. Energy prices have once again been the main concern, with both UK and European gas prices peaking last August before governments on either side of the channel intervened with various support measures. The recent mild weather has caused European gas futures to fall below the level they were trading at before Russia’s invasion of Ukraine, yet it would be brave (or foolish) to suggest energy prices are no longer a problem – particularly in the UK, where government support measures are being reduced for all but the heaviest industrial users.

In the UK, manufacturing activity fell for its sixth successive month in December, with the rate of decline among the steepest for 14 years, according to data compiler S&P Global Market Intelligence.

“Clients are increasingly downbeat and reluctant to commit to new contracts,” said director Rob Dobson.

Many FTSE 350 companies have found their home market to be a drag on performance – the UK’s economy was a laggard among G20 nations in the third quarter of last year, according to the Organisation for Economic Cooperation and Development. And although latest gross domestic product (GDP) figures for November suggest a recession could be avoided for the final quarter of 2022, most economists are predicting that outcome for the first half of this year.

The global picture is similarly downbeat in the near term, with weaker consumer confidence one reason why Moody’s Investors Service changed its outlook for manufacturing from stable to negative in November. Although supply chain bottlenecks are easing, with shipping and certain commodity prices showing signs of peaking, salary expectations continue to push up labour costs and gas prices remain volatile, the ratings agency said.

Bank of America analysts predict manufacturing activity will also continue to shrink across Europe and the US in the first half of this year before recovering in the second. It suggests the key to picking winners is to look at end markets. Companies supplying the aerospace, energy, chemicals and mining sectors stand a better chance of maintaining profitability than those serving consumer, housebuilding or transportation markets.

For FTSE 350-listed entities, this would mean favouring the likes of mining equipment supplier Weir Group (WEIR) or aerospace specialists such as Senior (SNR) and Melrose Industries (MRO) over heavier industrials companies such as foundry and refractory products specialists Vesuvius (VSVS) and RHI Magnesita (RHIM). Although there has been a brief rally in steel prices, this is more the result of restocking in Europe than any strong fundamentals, according to UBS. The World Steel Association’s latest forecast is for demand growth of 1 per cent this year, a downgrade on its previous estimate of 2.4 per cent.

RBC Capital markets analyst Mark Fielding expects a 5 per cent increase in organic revenue growth for a wider group of around 30 European industrial companies this year, although only about 1-2 percentage points of this will be due to volume growth, with the remainder a result of price increases to recoup costs. Although companies’ order books are expected to be worked down this year, they'll remain above their long-run average, he predicts.