Questor Share Tip: Rotork shares look expensive

Rotork
£28.13+59p
Questor says SELL

INDUSTRIAL valve specialist Rotork [LON:ROR] said yesterday that its first-half profits had been hit by the strong pound. And Questor thinks the shares, which trade on a premium rating, are looking exposed: the company has a lot to do in the second half to meet expectations.

The Bath-based engineering group manufactures high pressure valves that are mainly used in the oil and gas industry. The company generates about two-thirds of its profit from valves used to control flow rates in the oil and gas refining process, with the remaining third of profit largely coming from valves on pipelines and small gears and instruments businesses.

The company has been boosted by the ever-growing global demand for hydrocarbons. The share price has almost tripled during the past five years as pre-tax profits have jumped 71pc and investors have been rewarded with an 88pc increase in the dividend. It helps when the oil price is above $100 as it is at the moment. However, the company is currently suffering from the impact of a strong pound.

A new manufacturing facility was completed in Leeds during the first half of the year and the company is incurring costs in pounds while the revenues it makes in US dollars and euros are falling.

The FTSE 250-listed engineer said that first half pre-tax profits were down 3.3pc to £61.5m, on revenue up 0.9pc to £278.5m. Stripping out the impact of movements in foreign exchange the company said adjusted pre-tax profits increased by 7pc, on revenue up 4.4pc.

Rotork has historically had a fairly even split of profits between the first and second half of the year. The three-year average of profit distribution has been weighted marginally, or 53pc, in the second half, according to broker Liberum. The valve maker has £61.5m at the half way stage but needs to achieve £95.5m in the second half to hit market consensus for full-year pre-tax profits of £157m. That looks a tough ask.

The company is certainly winning more work. It achieved a record order intake in the first half of £302.7m, up almost 3pc on the same period last year. Demand for valves in the Far East and Latin America remains strong and the company secured another large order in Mexico. Elsewhere India is showing signs of improving and the US should enjoy a better second half after a cold-affected start to the year.

The total group order book increased by 7.4pc to £203m from the end of December. Management confidence was also underlined by a 6pc increase in the interim dividend to 19.2p, ex-dividend on August 27 and payable September 26.

But Questor is concerned that investors look exposed as the share price looks overstretched. The cash generated from operating activities in the first half was £39.5m, down 22pc on the same period last year.

The investment on the new facility in Leeds resulted in capital expenditure almost doubling to £8.7m, when compared to the first half last year. The acquisition of the Korean valve maker YTC for £64m in March also led to a cash outflow. The company had net cash of £14.9m as at June 30, down from £68.9m six months earlier.

Rotork shares are trading on 21 times forecast earnings, falling to 20 times next year. That looks high for a company delivering single digit earnings per share growth and offering a dividend on a prospective yield of 1.9pc.

Rotork shares also trade at a 20pc premium to sector peer Weir Group, a 35pc premium to the wider oil and gas service sector and 20pc above its long-run average price earnings ratio.

The company is trading well and strong demand in the oil and gas sector is driving growth in the order book. Rotork is a cash generative business that has reinvested in growth overseas which is attractive, but the shares have priced this in and more. Sell.