The Investment Column: Smiths is likely to fall further

SMITHS INDUSTRIES, the engineer that fell out of the FTSE 100 earlier this month, disappointed the City yesterday by admitting that it was unlikely to clinch the pounds 1bn deal it has long mooted.

Keith Butler-Wheelhouse, the chief executive, said his target markets hadn't evolved as expected. While Smiths still sees scope for pounds 100m deals, the focus now must be on the core businesses.

Of the group's three divisions, only aerospace - 40 per cent of group sales - is delivering decent earnings growth. Last year its profits rose at twice the rate of corresponding sales, helping the group deliver overall organic sales and profits growth of 8 per cent.

While the majority of Smiths' aerospace activity serves the defence market, it is the high-margin civil spares and retrofits business that is the real profits driver.

Smiths' position in the spares market is hard to replicate - it supplied the equipment in the first place - so the risk comes not from possible newcomers but rather from US airlines cutting back on refits. That risk is hard to quantify, but any downturn here would have severe consequences for Smiths.

Supplying original equipment to Boeing generates the remaining aerospace sales; Smiths itself has warned of an impending slowdown here. Naturally, Smiths says buoyant defence and spares demand will offset that.

Meanwhile, the group's other legs, medical systems and industrial components, continue to deliver flat profits, largely provided by US sales. The former is dogged by weak Asian markets, the strong pound and pricing pressure, but showed signs of upturn in the second half. Weak UK and European markets are hampering the industrial business, Smiths says, though an upturn in the European economies could generate a recovery. Even so, Smiths' message is not to hold one's breath.

Smiths' long-term ambition is not just to re-enter the FTSE 100, but to make it to the top 50. The civil aerospace spares market will not take it there, and Smiths will have to spend more than the pounds 93m it spent last year on acquisitions to achieve that goal.

Analysts' pre-tax profit forecasts range from pounds 237m to pounds 262m, with earnings per share spanning 53p to 58.4p, putting the shares on a forward price/earnings ratio of around 15.

The newsflow from Smiths looks more likely to be on the downside going forward and the shares, though off their 1074p high at 860p, could fall further.