The engineering giant Renishaw has more than a contraction in manufacturing activity hanging over its shares. A sales process started, and then disbanded, last year has investors wondering exactly when and how the group’s founders, the executive chairman Sir David McMurtry and John Deer, non-executive deputy chairman, will offload their stakes in the company. Management is “assessing other options” but won’t say what exactly they are.
The shares have fallen by almost 50 per cent since last year’s record high and trade at just 19 times forward earnings, a pessimistic profit multiple that, before this year, was not recorded since before the Brexit referendum. But the extent of the sell-off in the shares looks overdone.
The company is based in the Cotswolds and makes micro-instruments used in industries ranging from plastic surgery to phones and aerospace. Last year it benefited from a rebound in demand for its precision engineering equipment and in encoders that reposition machine tooling to the micron or nanometre, which pushed revenue to a record level.
• Computer chip warning mars outlook for Renishaw
Contracting manufacturing activity is the bad omen for that rate of profit growth continuing in the near-term. Renishaw is well diversified by geography, with Asia-Pacific accounting for just under half of revenue, and the Americas and Europe, Middle East and Africa contributing the rest.
It also sells to a vast array of end markets, none of which accounted for more than 29 per cent of sales last year. But the electronics market is a big one, contributing 27 per cent of sales, which means Renishaw still has a fair degree of exposure to consumer spending.
More broadly, there is the contagion effect of companies tightening their spending plans this year. The equipment Renishaw produces is typically used in machines funded out of capital expenditure budgets, which are more likely to be cut if consumer demand worsens. Tighter budgets for smaller manufacturers is likely to be more of an issue, but less so for customers in other sectors like defence and aerospace, according to Will Lee, the chief executive. The latter alone accounted for around 12 per cent of sales last year.
A cautious tone from management about the outlook was enough to prompt a cut to earnings forecasts. Analysts at Peel Hunt cut their pre-tax profit forecast for this year to £166 million, from the £188 million that the brokerage had pencilled in. If accurate, that would translate into a slowdown in annual profit growth to just 1 per cent this year, down from 37 per cent over the 12 months to the end of June this year.
The shares edged lower again yesterday — down 36p, or 1 per cent, to £34.84 — on the back of earnings figures for the last financial year, but there is reason to think that the market is valuing Renishaw too harshly. Apply a dramatic 20 per cent cut to the engineering giant’s earnings forecast for this year and the shares’ forward profit multiple moves up to 23, still a way below a ten-year average multiple of 29.
Renishaw has other attractive attributes that might lure the longer-term investor. Those include a net cash balance of £253 million at the end of June, which it intends to spend partly on building a new manufacturing facility and potentially on bolt-on deals that could broaden its product range. The kit the group supplies is vital for manufacturers to comply with certain regulatory standards, which generates a good degree of customer loyalty.
The group has strong pricing power, which has also helped limit the impact of cost inflation, and price rises should add another couple of percentage points to revenue growth this year. Admittedly labour costs have a bigger influence on the bottom line than manufacturing expenses, and a pay increase at the start of this year will add around £20 million to the wage bill this year. Analysts think margins will be held broadly flat this year.
Management may have ruled the sales process terminated, but the sharp devaluation of sterling may yet entice speculative offers to emerge. In the medium term, the perpetual drive to automation and robotics in manufacturing could produce the earnings progress Renishaw needs to win back investors.
ADVICE Buy
WHY High margins and the return of steady revenue growth could engineer a recovery in the medium term
DFS Furniture
The market had already priced DFS Furniture for a cut to earnings guidance, marking the shares down almost 50 per cent this year even prior to yesterday’s profit warning. Guidance is the problem, or more precisely interpreting it.
Just how badly will consumers take rising energy bills and higher shop prices this winter? For DFS, huge uncertainty means that management has set out a gaping profit guidance range for this financial year, pointing to pre-tax profits being anywhere from £20 million to £54 million, down from £60.3 million last year.
That guidance comes on the back of three different scenarios set out by the furniture retailer, for a decline in sales volumes of 5 per cent, 10 per cent or 15 per cent this year against pre-pandemic levels, as consumers cut back on spending on big ticket, discretionary items.
The shares might need to fall further to take account of the risks ahead. Taking the midpoint of that profit guidance leaves the shares trading at around 12 times forward earnings, which is not particularly cheap compared with the retailer’s longer-term history.
Why else might investors want to prepare for a worst case scenario? Limiting the decline to 10 per cent depends on the improvement in sales volumes experienced in the first two weeks of September continuing for the rest of the financial year, which ends in June. That is a big ask given that consumers have yet to feel the worst of higher energy prices.
Management eschewed a policy of holding or increasing the ordinary dividend, declaring a final dividend of 3.7p in respect of the last financial year, down from 7.5p the year before, using the £10 million difference between the two payments to take advantage of the low share price and buy back shares in the company.
Investors should dim expectations for dividends this year, too, in light of weaker earnings prospects. The broker Jefferies cut its forecast for this year to 6p a share, which would represent a yield of 4.5 per cent at the current share price.
ADVICE Avoid
WHY A further decline in consumer spending could see profits miss expectations
