2023-08-31 08:47:32 ET
Summary
- Flow control specialist Rotork has seen strong revenue and profit growth, but its shares are still rated as "sell" due to high valuation.
- Despite potential cyclical risks, the company's business model is expected to continue performing strongly, especially with its new Growth+ strategy.
- The company's shares currently yield 2.2% and trade on a P/E ratio of 24, which is considered high despite a drop from 30 in 2020.
Flow control specialist Rotork (RTOXF) continues to perform well as a business, with strong revenue and profit growth. I would happily buy into the business - at the right price.
I last covered the piece in an August 2020 "sell" article , since when the shares have slipped 4%. Although the valuation today is more attractive than it was then, thanks to a combination of profit growth and a lower share price, I still do not consider it to be highly attractive. So, for now, I continue to rate the shares as "sell".
Business Model Continues to Deliver
The underlying strength and appeal of the company's business model focussed on its specialist flow control capabilities is borne out by a quick look at last year's results. The company grew its order book, revenue and profits strongly.
The reason I would happily hold Rotork in my portfolio (if I could but into it at an attractive price) is that I think its business model could enable to keep on performing strongly for years.
Although cyclicality is a risk, particularly in the next several years if a tough economy leads customers to cut back on non-essential maintenance, in the long run, the company benefits from the pricing power its expertise gives it in a market where industrial customers are willing to pay for services that keep their operations running. Water and waste continue to see large infrastructural investments in markets around the world, something that benefits a provider of products like Rotork.
In fact, Rotork is essentially doubling down on its longstanding proven strategy, which I see as a positive development. Last year, the firm unveiled a new strategy , daftly named Growth+. It envisages Rotork as the leader in intelligent flow control. The strategy aims to help Rotork deliver on its targets of mid to high single-digit revenue growth and mid 20s adjusted operating profits over time through three levers: target segments, customer value and innovative products and services. None of that is rocket science, but I think it could be an effective strategy to help Rotork build on its strong base and, over time, hopefully grow its structural profitability.
Dividend
The company had a long record of annual dividend rises but blinked during the pandemic and cancelled its 2019 final dividend. The following year saw a higher payout to compensate, but the long track record of annual dividend increases ended. The dividend last year grew 4.7%, and the payout now stands 14% higher than it did in 2018, before the pandemic.
Currently, the shares yield 2.2%.
Last year, net free cash flow was -£10m, after paying £55m in dividends. The previous year was even worse, with a free cash flow of -£63m after paying £75m in dividends. Given its about turn on dividend increases during the pandemic and the recent cash flow question, I think it is a legitimate question to ask whether Rotork will sustain its current dividend. My gut feel is yes, for management credibility, but in the long term, it will need positive cash flows to do that.
Valuation
The shares currently trade on a P/E ratio of 24. That is cheaper than the 30 they commanded when I penned my last article in 2020, but still looks high to me.
I expect profitability could be uneven in the coming several years, if the economy stutters and some clients cut back non-essential maintenance expenditure. A lower energy price could also see clients in that sector cutting back capex, hurting revenues and profits at Rotork in what was its biggest segment by both revenue and profit last year. But over the long run, I expect Rotork to deliver profit growth. I think it has a strong business model with a good moat due to its installed base, engineering expertise and network of client relationships.
The issue that would stop me buying it for now is valuation. Its P/E ratio is not unusually high: fellow U.K.-based specialist engineer Spirax-Sarco (SPXSF) has a 34 P/E ratio. But that on its own does not mean Rotork offers good value, in my view. It offers a low yield compared to much of the wider U.K. market right now. Over the long term, the shares have languished. Over the past five years, they are down 12%.
I expect the business will continue to improve its performance and grow. But the share price had previously got ahead of itself. In my view, it still has a way to go before it offers good value again. A year ago, when the price was 26% below where it is today, I think the picture was different. But the current valuation still looks a bit rich for me, so I maintain my "sell" rating for now.
At half the current price or so, this would be a bargain. At the current level, it is not.
For further details see:
Rotork: Great Business But Still No Bargain