Spirax-Sarco’s quality shines through

We’re not alone in our thinking. Spirax is a top 10 holding of the Liontrust Special Situations Fund (GB00BG0J2688), one of the IC’s top picks for UK equity growth last year. The fund looks for companies with a “durable competitive advantage” that can sustain higher-than-average levels of profitability. Manager Anthony Cross calls Spirax “one of our favourite stocks”, highlighting its dominant market position, intellectual property and strong distribution network. He believes industrialisation of emerging markets is a key long-term growth driver.

Keeping true to its origins as a steam trap importer back in 1888, the steam specialities business produced 60 per cent of the group’s £283m of adjusted operating profit in 2019. But faster growth is coming from Watson-Marlow, which designs and manufactures ‘peristaltic’ pumps to keep fluids moving. Profit here jumped 13 per cent to £96m on the back of a 31.8 per cent margin. This compares with a still impressive 22.8 per cent margin for the wider group. Electric thermal solutions is the chink in the armour, with a weak first half from 2017 acquisition Chromalox pushing the margin down 1.4 percentage points to 13.3 per cent.

The dependency on global industrial production does create some cyclical exposure, but past performance suggests overall resilience. Amid virtually no global industrial growth in 2015 and 2016, organic sales grew2 per cent and 4 per cent, respectively. Still, analysts at Berenberg are forecasting a “meaningful” sales decline of 8 per cent this year. 

While Spirax is not recession-proof, around half its sales come from defensive end markets such as pharmaceuticals and biotechnology. It also derives 85 per cent of revenue from customers’ day-to-day operating expenditure budgets, which are less likely to be cancelled or deferred than investment in new facilities. It is a 50:35 split between repair and maintenance activity and small projects that upgrade customers’ assets. The latter is more valuable, with a typical invoice worth up to £50,000 versus £1,000 for maintenance. This feeds into Spirax’s “self-generating” revenue strategy, underpinned by a business model that leans towards direct sales rather than margin-diluting distributors. With the group’s engineers visiting customers’ facilities and identifying efficiencies. Strong relationships with customers and a deep understanding of their operations helps drive organic sales growth and is key to outperforming wider global industrial production growth.

There’s no word yet on whether the 78p final dividend declared in March will survive. But Spirax has increased its total payout for 52 years and is good at generating cash. The acquisitions of Chromalox and Gestra swung the group into a £374m net debt position in 2017, equivalent to 1.4 times cash profits (Ebitda). But by the end of last year, net debt (excluding £39m in lease liabilities) had reduced to £295m, a manageable 0.9 times cash profits.