Smiths Group announces record orders and a change at the helm

Shares in Smiths Group (SMIN) have flatlined over the past 12 months, but the market reacted positively after the engineering group announced £100mn in new share buybacks, together with organic revenue growth of 3.9 per cent at the half-year mark. The group also announced that Roland Carter is taking over as chief executive following Paul Keel's surprise decision to step down from the top job. Carter, a long-termer at the group, formerly headed up the Smiths Detection unit.

Indeed, Smiths Detection, alongside the John Crane business, were the major contributors to top-line growth, delivering growth rates of 8.9 and 12.7 per cent, respectively. Operating leverage on higher sales volume resulted in margin expansion at John Crane, and it would be reasonable to expect that matters could improve further given that investment in automation at the business unit has been a corporate priority.

Management points out, with some justification, that the interim results must be seen in context against a strong comparator in 2023, but perhaps the most pleasing aspect was the 16.5 per cent hike in the order book, with double-digit order growth across the largest business units. Order growth at Smiths Interconnect rebounded during the second quarter after a stuttering start to the accounting year, while performance at Flex-Tek was held in check by softness in the US construction market. Management anticipates that the latter business will return to growth in the second half.

Operating profit at £246mn rose by 5.3 per cent on an organic basis, with an accompanying 20 basis point increase in the underlying margin. Return on capital was heading in the right direction, which is doubly positive given a 5.6 per cent increase in capital expenditure through the period. 

Improved housekeeping, particularly in relation to working capital management, saw operating cash conversion rise to 26 percentage points to 89 per cent, while free cash flow generation more than doubled to £112mn. The group ended the period with net debt equivalent to a manageable 0.9 times cash profits, even allowing for the buyback.

Conditions are expected to improve in key markets such as aerospace, security and energy, although the timing of interest rate retracement – an important consideration – remains open to question. The asking price of 16 times consensus earnings is about par from an historical perspective, but reaffirmed guidance of organic revenue growth within the medium-term target range of 4-6 per cent, underpinned by “record order books”, along with the prospect of margin expansion, is enough to justify our long-term interest. Buy.

Last IC view: Buy, 1,650p, 26 Sep 2023