European small and mid caps-Stock picks Q4 2007-Q1 2008 - Fourlis

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Mid cap European small and mid caps 17 October 2007 abc Spectris Market-leading niche supplier of testing and inspection equipment Robust demand backdrop and restructuring should drive strong near-term EPS growth Rising CFROI and low cost of capital lead to 1,010p target price, reiterate Overweight rating Investment summary Spectris is a niche producer of testing and inspection equipment, serving a broad range of end-markets and selling directly to a largely bluechip customer base. The group typically invests around 7% of sales in R&D and develops whollyowned intellectual property in order to differentiate itself on product excellence rather than price. Although the aftermarket represents a modest proportion of total sales (c25%), unlike many of its competitors Spectris is reluctant to sacrifice product margin in search of more stable service revenues. Market backdrop is especially robust The group is currently benefiting from a strong industrial backdrop in emerging economies, combined with buoyant market conditions in Continental Europe. Together, these areas account for nearly two-thirds of group sales. Medium-term demand is underpinned by positive drivers for testing and inspection, supported by environmental regulation on emissions, noise, waste, and health and safety, for which trends are increasingly migrating towards developing markets. Furthermore, despite the group’s market exposure being fairly diverse, we estimate that process industries account for c50% of sales – this is an area where we forecast a 13% increase in capital investment over the next two years. Margins reaching respectable levels Historically, Spectris’ margins have been uninspiring, but management’s efforts have recently focused on enhancing profitability through recent restructuring initiatives and disposals. As a result, we believe the group is now on course to meet mid-teens margin targets in FY 2007 (from 12.2% in FY 2006), despite substantial currency headwinds. Key facts ____________________Financial summary _____________________ ___________ Valuation summary ___________ Analyst: Gary Murphy Year to Revenue EBITDA HSBC HSBC HSBC Yield HSBC EV/ EV/IC ROIC HSBC Tel: +44 20 7991 6749 December (GBPm) (GBPm) net profit EPS EPS growth (%) PE EBITDA (x) (%) REP Email: gary.murphy@hsbcib.com (GBPm) (GBp) (%) (x) (x) (x) Current price (GBP) 9.08 12/2006a 642.6 66.5 54.6 0.44 22.5 1.9 20.7 11.8 3.4 18.4 1.2 Target price (GBP) 10.1 12/2007e 656.1 98.8 66.8 0.55 25.1 2.2 16.6 10.3 3.2 20.1 1.6 Mkt cap (GBPm) 1,088 12/2008e 687.5 101.0 71.4 0.62 12.2 2.4 14.8 9.3 3.3 21.1 1.7 Bloomberg SXS LN 12/2009e 715.5 101.3 77.3 0.67 8.2 2.5 13.7 8.5 3.1 22.6 1.6 Reuters SXS.L Source: company data, HSBC estimates 64
Mid cap European small and mid caps 17 October 2007 abc Organisational structure Spectris Process Technology Electronic Controls In-line instrumentation Products/ activities Particle measuring systems, x-ray analysis equipment, materials analysis, transducers, sound meters, vibration measurement. Load cells, transducers, strain gauges, signal conditioning, data acquisition systems, weighing systems, barcode scanning and decoding Infra-red, x-ray and microwave sensors, gas analysers, condition monitoring Businesses Bruel & Kjaer, Fusion UV, Malvern Instruments, PANalytical, PMS HBM, Microscan, Red Lion Controls BETA Lasermike, Bruel & Kjaer Vibro, BTG, NDC, Servomex Source: HSBC, Spectris Valuation – Attractive entry point In our view, Spectris shares remain inexpensive trading on 14.8x 2008e EPS. This represents a 5% valuation premium to its UK sector peers, but a 30% discount against its major US competitor peer group. We feel that with the imminent accomplishment of its medium-term targets, the strategy will shift from margin recovery to the balance of organic and acquisitive growth and consequently we think there is scope for a further re-rating of the shares. Company profile – at a glance Spectris is involved in the development and manufacture of a range of precision testing and inspection instrumentation and control equipment, which assists customers in improving the efficiency, quality and cost-effectiveness of their production process. The group’s niche focus gives rise to a fairly diverse competitor base, with rival players ranging from subsidiaries of large industry conglomerates, such as GE (in condition monitoring), Rockwell (electronic controls, UW, ROR US, USD71.7) and Siemens (OW, SIE GR, EUR98) and ABB (in gas analysis, OW, ABBN VX, CHF32.9), to niche players in the high-tech end of the analytical product range such as Horiba (Japan), Dionex, Danaher and Roper Industries, Perkin Elmer (all US) and Gefran (Italy). Investment case With underlying trading strong, H1 2007 organic sales growth reached nearly 8%. Given the growth in volume sales, we believe there is further scope to improve margins, as the benefits of operational gearing materialise and our model assumes a 40% rate of profit drop-through. Additionally, we remain comfortable that (EUR and USD) currency headwinds can be offset through the benefits of restructuring emerging over the next 18 months. Finally, impressive cash generation within Spectris: sales by end-market (2007e) Spectris: sales by region (H12007) Electronics 5% R&D 7% Energy & utilities 7% Semicons 3% Print and pack. 4% Manuf. 6% Pulp and paper 9% Other 20% Transport 15% Pharma/Chem. 12% Metals & mining 12% Rest of world UK Rest of Asia 6% 4% 10% China 8% Japan 8% North America 24% Continental Europe 40% Source: HSBC estimates Source: Spectris 65
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European small and mid caps-Stock picks Q4 2007-Q1 2008 - Fourlis

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