Whenever there is a discussion about ‘quality’ UK industrial stocks, the name Spectris (SXS) is often thrown into the ring although we suspect many investors, while being familiar with the company in a general sense, have little idea what it actually does.

Looking on Stockopedia, the company has a 99th percentile quality ranking, which backs up its reputation, but it is classified as a large-cap technology stock and a ‘high-flyer’, which doesn’t help a great deal in explaining the business.

So, what does Spectris actually do and is it an interesting investment?

A BRIEF INTRODUCTION

Spectris is divided into two main business units, making precision measurement equipment and software for some of the world’s most technically demanding applications, from aerospace and electronics to electric vehicles, and helping to solve a myriad of environmental issues such as monitoring and reducing micro-plastics and even working out how Galapagos tortoises self-right themselves.

Spectris Scientific makes equipment for material analysis for the pharmaceutical, semiconductor and materials sectors, measuring particles down to the nano scale to help its customers shape everything from proteins, metals and polymers to controlling the manufacturing process, and contributes 56% of the group’s turnover.

Spectris Dynamics is a global leader in advanced virtual and physical testing and high-precision sensors for the automotive, machine manufacturing, aerospace and technology sectors, and contributes the remaining 44% of group turnover.

It works in what it calls attractive, sustainable, structural growth markets with high barriers to entry, using an asset-light model and investing in its own R&D (research and development) as well as seeking out attractive bolt-on acquisitions to maintain its industry-leading position in each business.

The firm has set itself some fairly rigorous financial and sustainable targets, including a mid-teens percentage return on capital employed, a 20% operating profit margin, 80% to 90% free cash flow conversion, to be net zero across its operations by 2030 and to be net zero across its ‘value chain’ – meaning including its suppliers and distributors – by 2040.

With a market cap of £3.4 billion, the group is within touching distance of the FTSE 100 index, but as it is it sits at the top of the FTSE 250 mid-cap index alongside budget airline EasyJet (EZJ), insurer Hiscox (HSX) and housebuilder Vistry (VTY).

Its closest peers in terms of the stock market are Halma (HLMA), which we looked at in a previous edition of Under The Bonnet, and Oxford Instruments (OXIG).

HOW IS THE COMPANY DOING?

Spectris has spent the last couple of years streamlining itself, with the defining moment being the sale of the low-margin Omega unit in 2022 for £410 million bringing disposals over the three years to that point to over £1 billion.

The sale was well-received by the market given it fetched a multiple of more than 20 times 2021 adjusted EBITDA (earnings before interest, tax, depreciation and amortization) compared with the group’s valuation at the time of just 11 times EBITDA.

As well as returning cash from the Omega deal, Spectris consulted with its major shareholders before making a canny US acquisition in the shape of Dytran Instruments, a US sensor-maker, strengthening its offering and expanding its sales presence in the key North American aerospace and defence market for relatively little outlay.

Shortly after Spectris acquired it, Dytran booked a ‘notable’ order from a large spacecraft manufacturer, and the deal serves as a good example of the firm’s ability to compound growth through selective M&A.

Last year, the company reported a 10% increase in like-for-like revenue to £1.45 billion. It also posted an 18% increase in operating profit to a record £262 million – representing an 18% margin on sales – and a 25% increase in earnings per share to almost 200p. This confirms our analysis that it has compounded profits at just shy of 10% per year on average since the late 1980s, a feat to which few UK firms can lay claim.

Cash conversion was 103%, well above the medium-term target of 80% to 90%, and return on capital employed was 18.5%, again above the self-imposed target of mid-teen returns.

2023 marked the third year of double-digit like-for-like sales growth, and it is worth noting both divisions contributed to the outcome with Scientific revenue up 12% and Dynamic revenue up 6%, while operating margins at both businesses were higher at 22% and 17.2% respectively.

Even more impressive, on top of a £300 million buyback, which was extended by a further £150 million at the time of the results, the firm raised its dividend to make it 34 years of continued growth in its payout to shareholders.

WHAT IS THE OUTLOOK FOR 2024?

Interestingly, analysts are downbeat about the company’s growth prospects this year, meaning expectations are low, which can be quite helpful if you a growth company as it means there is scope to surprise the market to the upside.

Berenberg’s Callum Battersby describes Spectris as facing a ‘challenging organic set-up, particularly in the first half’ due to the tough comparison with last year when it was working through a sizeable backlog of orders which had been delayed due to supply-chain issues.

He expects the group to report lower like-for-like revenue in the six months to June, meaning a ‘significant’ recovery is needed in the second half for the firm to show any top-line growth.

This means there are downside risks to earnings forecasts and ‘the shares are more likely to next move down than up’, he concludes.

Tom Fraine and Akhil Patel at Shore Capital are equally gloomy, expecting consensus operating profit forecasts to be downgraded by between 7% and 8% due to divestments leading to a mid-single-digit downgrade to pre-tax earnings.

In summary they flag ‘the uncertain short-term outlook and lack of a clear catalyst’. 

Therefore, it’s fair to say there isn’t a lot of love for Spectris at the moment which can often be the best time to look at a company.

For what it’s worth, the company-compiled consensus sees 2024 like-for-like sales growing at 3.4% this year against almost 10% last year while adjusted operating profits is seen inching up to £272 million and earnings per share are forecast to grow a miserly 3.5% to 207p.

The first test of whether analysts are on the right track will come in early May when the firm reports its first-quarter earnings, so we will wait with baited breath.

FUND MANAGERS VIEWS

Leigh Himsworth, manager of the Fidelity UK Opportunities Fund (BH7HNY7) and an FE Alpha Manager for the last 15 years, has given Spectris and fellow engineering firm IMI (IMI) a top-10 place in the portfolio.

The fund specialises in finding ‘unrecognised opportunities’ among companies with ‘significant long-term growth that has yet to be appreciated by the market’, which would seem to sum up Spectris fairly well.

‘Spectris has always been a decent business with historically robust turnover through cycles and strong cash generation to boot. It has taken the current, excellent management team however to tweak each part of the business to hone the divisions into more distinct business units with a well-articulated plan that highlights the groups aims,’ comments Himsworth.

‘Careful asset management is delivering a rejuvenated business that offers investors growth in excess of 10% and operating margins just short of 20%, with a balance sheet that is forecast to have over £400 million of cash by the end of 2026 giving management a ‘nice’ headache of many possible options. Such a cash position means the stock trades on a highly attractive sub-10 times EV/EBIT (enterprise value to earnings before interest and taxes) to December 2026, a significant discount to the quality peers in the space.’ 

Peter Michaelis, manager of the Liontrust UK Ethical Fund (B8HCSD3) added Spectris to his holdings in December 2023 as part of the fund’s ‘better monitoring of supply chains and quality control’ theme.

‘Through measurement and analysis, the company’s clients can analyse and understand how to increase the effectiveness of medicines, develop longer range batteries, test new electric car designs and even electric planes,’ wrote Michaelis in his January 2024 fund commentary.

The head of Schroders’ pan-European small and mid-cap team, Andy Brough, says: ‘When companies are doing well then investors tend to assume that has always been the case but they can have spent a long period in the wilderness before they got there. We like companies that have gone from hero to zero back to hero and in most cases it is the management that make the difference.’

Brough observes that Spectris floated on the market as Fairey Group and, under the leadership of John Poulter it became a ‘stock market darling’ with a combination of organic and sensible acquisitions. 

He adds: ‘When he left the business’ share price struggled. The new management team changed the name and went on a wild acquisition spree which kept them busy but lost shareholders money. 

‘When Andrew Heath arrived the first thing I did was put him in touch with John Poulter so he could hear about the time Spectris was a hero. Under the leadership of Andrew the business has been refocussed and reorganised and is now on its way back to being the hero it first started out as.’ 

DISCLAIMER: The author of this article (Ian Conway) has an investment in Halma.

‹ Previous2024-03-28Next ›