Smiths has a record of supplying equipment to the Transportation Security Administration and has secured previous CT orders from the agency

Business Strategy and Outlook

Smiths Group is a collection of industry-leading niche businesses, each producing admirable margins and returns; however, growth across the group is inconsistent, with different divisions enjoying periods of strong demand but at disparate times. Research and development spending as a portion of sales has increased by 50 basis points over the past few years. However, to accelerate group-level revenue growth, several innovations winners–not a single one–are likely necessary, given the breadth of products across the businesses. The innovation cycle for each business is also likely several years, and the fruits of the recent ramp-up in spending have yet to be seen. That said, a few of these product categories, particularly in security and safety, have emerging technology potential that could lead to new market opportunities. Management sees a potential GBP 200 million-250 million in gross new revenue opportunities in the medium term. The net number will be likely lower after considering cannibalization of existing products by new product rollouts. Smiths Detection is the division with the greatest potential to propel the group, as it offers security screening equipment with a potential addressable market beyond its current focus. The division currently specializes in screening equipment for airports and ports, mainly supplying to governments. The United States is an important medium-term end market for this equipment, and it is likely to go through a multiyear upgrade program, swapping out X-ray equipment for CT scanners. Smiths has a record of supplying equipment to the Transportation Security Administration and has secured previous CT orders from the agency.

Of the other divisions, John Crane is the most important cash flow driver, with a high portion of recurring revenue and an entrenched competitive position as the number-one supplier globally of mechanical seals. It faces a challenge over the coming years of managing likely declining revenue from its oil and gas customers with new products and end-market growth. Its deep expertise in improving seal performance suggests it should be able to offer compelling value to new end markets.

Financial Strength

Smiths Group exited fiscal 2021 (ended July) with net debt/EBITDA at 1.6 times, in line with management’s target of below 2 times. This brings debt to a level that could be paid down through operating cash flow in about four years, if refinancing options are not available. The company expects to obtain net $1.85 billion in proceeds from the sale of its medical division to ICU. Management plans to use 55% of the proceeds for share buybacks. The remainder will be reinvested in the business, including acquisitions, and offer balance sheet support. Smiths is well balanced, given the reasonable leverage levels and business needs to fill in technology white spots to support top-line growth. The annual operating cash flow of around GBP 300 million per year through the 2026 explicit forecast period. This leaves enough room to cover annual capital expenditures of about 3% to sales and a dividend payout ratio of 50%-plus.

Bulls Say’s

More than half of group revenue comes from recurring revenue sources, enabling Smiths to maintain operating profit margins well above 10%, even during troughs in the cycle.

Spending on more significant repairs of John Crane’s mechanical seals by refiners at oil majors should rebound in the next couple of years due to more favourable oil prices and ageing of the seals.
As an incumbent supplier, Smiths Detection is excellently positioned to gain orders from U.S. airport operators to install updated baggage screening equipment over the medium term.

Company Profile

With its start as a London jeweler in the 19th century, Smiths Group has for most of its history operated as a company operating disparate but economically attractive businesses. Thematically, it runs businesses that manufacture niche products in security- or safety-sensitive industries. Today, Smiths Group is split across four divisions: mechanical seals, weapons detection, electrical connectors, and specialized hoses. The end customers for these products include airports, NASA, government security or defense departments, and hospitals.

(Source: MorningStar)

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