Spirax-Sarco has room for improvement

Spirax-Sarco is made up of three business segments. Its main division, steam specialities, provides steam control and management systems, and accounted for 63 per cent of group turnover in 2018. Watson-Marlow, which specialises in fluid-path technologies, made up 23 per cent of Spirax’s revenues, and is performing well, contributing double-digit growth. Chromalox, a $415m 2017 acquisition that provides fluid control and electrical heating products, is the final division, accounting for14 per cent of revenues.

Chromalox is under intensified focus after a poor spell that saw first-half operating profit fall by a quarter. The division should be boosted by restructuring and Spirax’s £135m May acquisition of Thermocoax, a French electrical thermal products business that will look to leverage Spirax’s North American presence. In general, Spirax has a good acquisition record and Thermocoax is its first deal since Chromalox. Broker Berenberg sees the potential for three similarly sized deals to Thermocoax in the next three years, which it thinks could add 15 per cent to operating profits. 

The result of Chromalox’s disappointment has been a slump in the share price, which has only recently start to recover, having sat at a peak of 9,445p in early July. Investor doubts were exacerbated by management caution that industrial production forecasts for the second half had fallen below previous estimates, restraining the group’s full-year outlook. A global industrial production growth forecast for 2019 was revised to 1.6 per cent, around half the 3.1 per cent achieved in 2018. Growth in Europe and Asia Pacific, excluding China, was flat, while North America is behind its 2018 growth rate. Management has played down its second-half growth prospects against this backdrop.

While shares can be prone to large drops when they trade on a high valuation, as is the case with Spirax, we still feel the market reaction to a relatively minor disappointment from the group looks harsh. We are not overly perturbed by current growth rates, with first-half organic sales growth coming in at 8 per cent. Chinese industrial production actually grew at a rate of 5.8 per cent, above the Asia-Pacific average of 3 per cent. Spirax has made advances in the world’s second-largest economy. 

Direct sales, which are more profitable and better for customer relationships than a wholesale approach, are a key facet of Spirax’s strategy, and the business established a new steam specialities sales business in the country this year – it also secured a number of oil & gas and electronics orders and saw an increase in self-generated sales. Making inroads into China, while industrial peers are exiting the country, may seem counterintuitive, but Spirax’s core business grew its half-year revenues by 11 per cent organically over its first half – in spite of flagging economic activity.

Against the market turbulence, the operating margins for steam specialities and Watson-Marlow have held up at 22.9 per cent and 31.6 per cent, respectively. Spirax’s diverse, but niche, range of products has helped shield it from a more damaging economic fallout – Watson-Marlow has fared well in pharmaceutical and biotechnology products, which have experienced growth in every region and account for nearly half of the division’s sales. Spirax’s focus on its customers’ non-discretionary operating budgets (about 85 per cent of sales), as opposed to discretionary capital spending, also offers protection. Even the maligned Chromalox experienced an 8 per cent uptick in its order intake. Meanwhile, the first-half group operating margin was typically impressive at 21.9 per cent.