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Investments: The long-term outlook for commodities will deliver gains for Weir

Nikhil Kumar
Tuesday 08 November 2011 01:00 GMT
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Weir

OUR VIEW: BUY

SHARE PRICE: 1,860P (-71P)

Weir's share price has see-sawed quite dramatically this year, as investors in the manufacturer of pumps and equipment for the energy, power and mining sectors apparently alternate between optimism and pessimism about commodities.

Yesterday, they fell another 3.7 per cent as the market was hit by another bout of the jitters despite an upbeat third-quarter trading statement.

Essentially, investors appear to be caught between believing that commodity and oil prices are likely to remain lodged at current levels (and possibly fall) or believing that they will continue rising on the back of strong demand from China and other emerging economies. The confusion comes as they attempt to work out the impact of what could be another global recession. If realised, such a slowdown would hit demand for commodities and oil, reducing the profits of companies involved in their extraction.

For its part, Weir said yesterday that its revenue strengthened in the third quarter, as it reaped the benefit of a strong first-half order book. Reported orders increased by 27 per cent during the quarter, which meant that order input for the first 39 weeks of the year was up by 37 per cent.

However, the company did note that while conditions across the mining and upstream oil and gas markets "remained strong" through the third quarter, downstream oil and gas market conditions "remain challenging".

Overall, yesterday's announcement amounted to a positive statement that adds to the strong interim results the group unveiled in August, as a 33 per cent jump in revenues to £1.03bn prompted a 24 per cent rise in pre-tax profits to £178m.

To return to the apparent confusion among investors, although it's true that demand for commodities and oil could weaken in the coming months, the longer-term picture remains encouraging. We'd also point out that Weir has a good presence in shale gas – a form of energy released through a controversial practice known as hydraulic fracturing, or fracking. This blasts a mix of sand, chemicals and water into the rock at high pressure to split open the rock and release the gas.

Though this is currently facing opposition in the UK, the large reserves of shale gas mean that it is extremely likely that fracking will become widespread in the country in the coming years. And with plenty of experience doing the same in the US, Weir looks looks well placed to benefit.

Xchanging

OUR VIEW: HOLD

SHARE PRICE: 78P (+8P)

Xchanging, which provides companies with back office services including invoice processing and payroll, believes the hard times seen last year are firmly behind it.

The shares were given a boost yesterday after an update reassured the market, and the operating cash flow was ahead of expectations. The company, which specialises in financial services and insurance, has been slashing costs to support its recovery after losses of £56m in 2010, and warning on profits in February. It is about 12 months into chief executive Ken Lever's four-part recovery plan. The company believes the turmoil in the markets, especially among its core customers, represents a solid opportunity, as they will inevitably look to cut IT costs. It has also secured some prestigious contracts including L'Oréal and BAE Systems

Yet, there is the risk that that the economic climate worsens to the extent that its clients simply stop spending. Liberum Capital analysts believe the stock remains "high risk", although they added that on a price of 7.4 times estimated 2012 earnings the stock is hardly expensive.

There may well be some upside, but we would wait for the recovery plan to play out further.

Taylor Wimpey

OUR VIEW: HOLD

SHARE PRICE: 36.78P (-0.68P)

When we decided against buying Taylor Wimpey in July, we reasoned that the wider economic environment weighed against the thin valuation. Since then, the house builder has fallen back, though only very slightly. We said hold at just under 38p; last night, it closed at just under 37p.

So is it time to switch our stance? To begin with, yesterday's update was reassuring. There were no nasty surprises and Taylor Wimpey said its ambitions to improve margins remained on track. But it admitted that mortgage availability remains restricted, something that continues to worry us when it comes to the short-to-medium-term outlook for the housing market.

As we noted last time, the long-term case for Taylor Wimpey is intact. We like the company. And its shares are cheap. But sentiment around house builders is unlike to show a marked change until mortgages become more widely available and the economy begins to show some real life. That, alas, has not happened over the last couple of months. Keep put for now.

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