The new executive team faces much the same issues that the two previous CEOs encountered. The portfolio of businesses that form Smiths Group have little industrial synergy which, given its historical active transitions, raises questions over whether the current structure optimises value for shareholders. Further improving operational performance appears key to facilitating strategic decisions, aided by reduced pension cash funding.
At the half year, the group’s performance remains on track to deliver already subdued expectations for FY16. However, John Crane’s performance proved slightly less resilient than has historically been the norm, with a 7% decline in high margin aftermarket sales, worse than most expected. With Medical and Detection both modestly better and Interconnect and Flex-Tek essentially flat, overall group performance in the seasonally stronger H2 is expected to show a similar absolute decline in profits.
Smiths’ history has been marked by successful transitions in its areas of focus. More recently the group’s structure has remained broadly unchanged since the disposal of the aerospace activities in 2007. Unfortunately this period also coincided with the lower global growth dynamic, driven in part by more constrained government spending, a situation that has now been compounded by the reversal in energy markets for John Crane. While the evidence of the interim results confirms the high quality of the five divisions, we feel the new CEO and CFO will drive an even greater focus on operational improvement and cash-flow generation. The question of group structure has yet to be addressed.
Earnings expectations remain subdued for Smiths Group, with attainment of FY15 EPS not forecast even in FY18. Management appears comfortable with consensus for the current year. An improvement in this profile appears plausible as John Crane stabilises, but acceleration of the top line remains elusive. Management is seeking to improve cash performance alongside the operational enhancement, and the new pension funding arrangements in the UK provide a major kicker in this regard. However, until organic growth is re-established, a consensus P/E rating in line with the long-term average for the capital goods sector looks appropriate.