A mish-mash makes good

Smiths Industries, with its three disparate divisions, has snubbed the demerger craze
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The Independent Online
Smiths Industries is a strange, relatively unknown and some would say unique stock market animal. Membership of the dwindling band of large British companies that actually makes things is perhaps Smiths' greatest claim to fame.

Increasing its curiosity value further, Smiths has also cocked a snook at the current City craze for demerging, concentrating instead on three separately run divisions with little industrial logic between them.

This balance of aerospace electronics, medical equipment and industrial products such as ventilation fans and flexible tubing has served investors well in recent years.

The shares have outperformed a rising stock market by almost 50 per cent in the past 12 months alone, propelling Smiths into the FT-SE 100 index of leading companies at the back end of last year.

Latest half-year results seemed to justify Smiths' premium rating. Although the aerospace business experienced some disruption from a recent strike at Boeing, Smiths' largest customer, pre-tax profits rose by 19 per cent to pounds 69.5m on sales 13 per cent higher at pounds 466m.

On the military side, Western government defence cuts following the end of the Cold War have seen new orders virtually dry up. For example, Smiths notes that for the first time in living memory the United States Air Force is not taking delivery of a single fighter plane this year.

Elsewhere, confidence and profits are only now returning to a global airline industry ravaged by the twin impact of the Gulf War and recession.

As recently as six months ago Boeing, the world's largest aircraft maker, was forecasting no significant growth in the civil market until the end of the decade; Sir Roger Hurn, Smiths' executive chairman, thought civil- aircraft production would fall this year to its lowest level for more than 10 years; and some Jeremiahs were predicting that only 2,000 civil aircraft would be sold in the next six or seven years.

In the event, the civil aircraft market recovered faster than anyone expected as airlines and leasing companies finally resumed ordering. It now looks as though 1995, when manufacturers delivered just 481 planes worldwide, was the nadir year.

Further evidence of recovery came last week when Boeing announced it was taking on an extra 6,700 staff in the US to meet increased production schedules beginning in 1997. Smiths supplies $250,000 (pounds 165,600) of equipment for each of Boeing's short-haul 737 jets and $400,000 of electronics gear for its wide-bodied 777 series.

Even Smiths' military side is turning the corner, helped by a $100m contract to supply cockpit instrumentation for Raytheon's new US Air Force training aircraft. Analysts also expect Smiths to pick up work worth $1m a plane if, as seems likely, the Eurofighter moves into production from 1999.

Despite this improved outlook, however, Smiths realised long ago that supplying the aerospace industry is a highly cyclical business prone to long lead times and the potential for wild earnings swings.

Its response to these structural challenges has been swifter than most. First, staff numbers in the aerospace division have been cut by 40 per cent since 1990. Second, Smiths has built up its other, higher-margin divisions through a series of acquisitions funded largely from the group's strong cash-flow. (Despite a five-year pounds 350m spending spree, the balance sheet remains virtually debt-free.)

The latest acquisition, a pounds 69m deal signed last week for an electrical wiring protection business and a ventilation maker in the UK, means the industrial side, which also includes Vent-Axia extractor fans, has overtaken aerospace as the largest single division within Smiths.

But the most profitable area is medical systems, which specialises in surgical equipment and single-use plastic devices for critical and intensive care. It has enjoyed margins of 20 per cent-plus for the past six years.

Great potential for export growth is seen for this division's two recent US purchases, Deltic (infusion pumps) and Level 1 (blood- and fluid-warming systems). These products free beds by giving previously hospitalised patients mobility and speeding up recovery times, respectively. "These will be ideally suited to the European markets, which are five to seven years behind the US in terms of healthcare reforms," says the engineering team at Panmure Gordon in a note to clients.

The broker adds that almost 18 times next year's projected earnings is a fair price to pay for one of the best managed businesses in the sector.

Smiths Industries

Share price 714p

Prospective p/e* 18

Gross dividend yield 2.5%

Year to 31 July

1994 1995 1996* 1997*

Turnover pounds 759m pounds 899m pounds 992m pounds 1052m

Pre-tax profits pounds 117m pounds 138m pounds 176m pounds 175m

Earnings p/share 26.6p 31.3p 39.7p 39.5p

Dividend p/share 13.0p 14.4p 15.9p 17.5p

* City forecast

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