Rotork’s (ROR) most recent set of results in August presented a mixed picture for the precision engineering group. Poor macroeconomic conditions pushed first-half sales and order intake down and the near-term outlook isn’t spectacular, with flat sales growth expected for the full year. But Rotork beat consensus forecasts and its much-vaunted ‘growth acceleration programme’ continues to bring operational improvements across the company and to boost margins. So despite limited expectations over short-term earnings, we think the underlying quality of the business makes the shares worth a closer look.
Growth acceleration programme under way
Margin growth anticipated
Acquisition fire power
Shares not ‘cheap’
Rotork produces systems to help a host of industries – including oil and gas, water and chemical companies – to manage the flow of liquids, gases and powders. It has four divisions: controls, fluid systems, gears and instruments. None of these divisions are insignificant contributors to the group, but Rotork made half of its first-half turnover from its controls business, with fluid systems the next-largest revenue generator at 21 per cent of total turnover in the period. Controls and fluid systems both saw revenues fall over the first half, albeit against a strong performance a year earlier . Oil and gas revenues, which accounted for 54.3 per cent of group turnover, were down year on year.
Controls nevertheless saw a 3.7 per cent rise in order intake alongside its 2.5 per cent sales fall. The business makes actuators (in effect, control systems), and is the world’s largest independent manufacturer of heavy-duty valve actuators. More importantly, the division is reaping the benefits of a turnaround programme launched in 2017 that includes a focus on operational improvement. Its adjusted operating profit margin increased from an already healthy 27.6 per cent to 29.7 per cent, against the first half of 2018. Overall group margins increased from 19.8 per cent to 21.1 per cent.
The turnaround programme also encompasses commercial improvements, talent acquisition and the improvement of IT and core businesses, but it is its focus on “operational excellence” and supply chain modification that is most pertinent to our buy case. A “mixed-model lean/continuous improvement programme” is in place and has particularly strengthened the business in the Far East. Rotork is consolidating its supply chain and reducing inventory levels. The programme has freed up space and will enable the closure of three manufacturing facilities this year. Supply chain procurement initiatives look set to save £5m in 2019. Rotork’s stock reduction programme led to a net £7m reduction in its first-half period, or a £13.9m reduction compared with June 2018.
These improvements and a growing focus on other aspects of working capital management are filtering through to Rotork’s balance sheet and improving the underlying health of the business. Overall net working capital fell by £10.4m in the first half to £182.6m. It converted 113.6 per cent of adjusted operating profits into operating cash, or 117.4 per cent based on new lease accounting standards. It boasts a net cash position and a standout adjusted return on capital employed of 29.7 per cent. This helped to support first-half capital expenditure of £8.1m.
All of this places Rotork in a strong position to take forward the “commercial excellence” angle of its growth programme. It launched seven products over its first half and aims for 15 by the close of the year. Despite the fall in group-wide order intake, analysts at Berenberg noted an uptick in the second quarter and a book-to-bill multiple of 1.14, which tells us Rotork’s ratio of orders to completed sales sits at its highest level in a decade. Berenberg analysts believe that the strength of Rotork’s balance sheet now gives it around £400m for acquisitions. The group is targeting mid-to-high single-digit revenue growth and operating profit margins of between 25 and 26 per cent.
|ORD PRICE:||308.7p||MARKET VALUE:||£2.7bn|
|FORWARD DIVIDEND YIELD:||2.2%||FORWARD PE RATIO:||26|
|NET ASSET VALUE:||58.5p*||NET CASH:||£43.0m|
|Year to 31 Dec||Turnover (£m)||Pre-tax profit (£m)**||Earnings per share (p)**||Dividend per share (p)|
|Normal market size:||7,500|
|*Includes intangible assets of £281m, or 32.2p a share|