Shares in international engineering giant GKN (LSE: GKN) fell in early deals this morning after it published results for the first six months of 2017.
The company reported that pre-tax profits rose to £559m in the first six months, up from £182m in the same period last year. Headline sales increased 15% to £5.2bn the period, although trading margins declined by two basis points to 8.4%. Excluding one-off factors, and according to management’s own interpretation of the figures, overall organic trading profit increased by £7m for the period with a currency benefit of £47m and an £8m charge due to acquisitions/divestments. Along with these mixed results, it also said it is paying £250m to help address the deficit in its defined benefit pension scheme which was closed in March. At the end of June, the pension deficit stood at £1.1bn.
Mixed figures
Over the past five years, GKN has grown steadily, increasing sales by around 9% per annum on average. However, this growth has failed to make its way to the bottom line with pre-tax profit falling from £568m in 2012 to £292m in 2016. Over the same period, earnings per share have risen, but only just, growing by a total of 19%, or around 4% per annum.
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The divergence between revenue and profit growth means that GKN’s return on capital has declined from around 13.7% in 2013 to 5.3% for 2016 and return on equity has declined from 32.9% to 12.1%. In other words, the company is becoming less productive as it prioritises sales growth over income.
Deserves a low valuation
Based on current city estimates, the shares are trading at a forward P/E of 9.5, which might seem attractive to bargain hunters but considering the group’s stagnant profits and falling efficiency, this low multiple seems about right.
By comparison, smaller peer Trifast (LSE: TRI) has been able to grow net profit at a compound annual rate of 32.1% for the past five years as revenue has grown by 10.6% per annum. It has been able to grow earnings faster than revenue because the group has become more productive as it has acquired new businesses to help boost organic growth. Return on capital has increased from 8.8% in 2012 to 14.6% for fiscal 2017.
Based on these figures, it’s no surprise that shares in Trifast have outperformed those of GKN, rising 411% since mid-2012 excluding dividends. GKN has only clocked up a performance of 50%. Over the next two years, city analysts have pencilled in earnings per share growth of 30% for Trifast as the company continues to grow organically and through acquisitions.
Worth paying a premium for
Compared to GKN, Trifast’s shares are expensive, trading at a forward P/E of 16.7. Nonetheless, this multiple does not seem overly expensive when you take account of Trifast’s robust historic expansion and future potential.
If management can keep the company on its current course, this multiple could actually undervalue the firm’s long-term potential.
