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Questor: plumbing giant Ferguson sprang a major leak 14 years ago but today it is much more resilient. Buy
Questor share tip: a rocky time for the plumbing supplies company prompted new management to transform the business for the better
Companies, like people, can sometimes gain strength from adversity. Ferguson, the plumbing supplies business formerly known as Wolseley, is a good example.
The firm, which operates largely in America, got itself into “a bit of a pickle” when the market for US new-build housing crashed about 14 years ago, said Ciaran Mallon, manager of the Invesco Income Growth investment trust.
“It had to raise money via a rights issue,” he said. “But since then a new management team has been transforming the business.” He said they had shed the north European operations to focus on “the best business they had” – the American one.
“They exited non-core parts and invested in making the core better than rivals. A lot of that competition is ‘mom and pop-style’ single sites or small chains.
"But things are changing and customers, whether small builders or large contractors, want to deal electronically, perhaps over smartphones. And they need good service.”
He said all of this suggested that “a big, well invested business is well placed to outcompete smaller players”.
Some of the latter are happy to sell, giving Ferguson scope for acquisitions, while America’s vast scale and the fact that some areas have no plumbing suppliers at all mean opportunities for organic growth.
“It’s a fragmented market – the company is the biggest or second biggest in some activities but its market share is still low,” Mr Mallon said. “Most of the market for what they do is in the hands of small competitors.”
Organic growth has been between 4pc and 9pc over the past nine years – “they must be doing something right to grow like that at a time when growth generally is weak” – while operating margins in America have risen over the same period from less than 6pc to 8pc now.
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He said the firm’s financial discipline had been “wonderful” in its decade under new management. “It has strong cash flows and makes good use of them, via share buybacks for instance, while returns on capital are strong and growing as it exits lower-return businesses.”
Net debt is less than a year’s profits on the “Ebitda” measure, making the balance sheet “very comfortable”, the fund manager said.
In terms of risks, he mentioned the state of the American economy and the fear among some investors that Amazon could enter the market.
“But what it offers is a very bespoke service – if the things you need as a contractor are not on site at the right time you may have to pay people to be idle and any marginal saving from buying from Amazon is going to be swamped,” he said. “So I think it’s not that great a threat now, although I’m keeping an eye on it.”
He added: “This is a business that has invested in making itself really helpful to customers, making their lives easy and their days profitable. By doing so it has grown and has room to grow more. This is a chance to own a company that offers organic growth and very strong management, which is doing well for all the right reasons.
"A business that has gone through such a sticky patch does not forget it, so it is run to be resilient.”
Questor says: buy
Ticker: FERG
Share price at close: £72.16
Updates: Whitbread, Smith & Nephew
Both of these stocks have been tipped here in the past on the basis of Ciaran Mallon’s belief in them. He said he “hadn’t found anything to match Whitbread”, which still offered “fantastic growth opportunities” in Britain and was building its presence in Germany.
At Smith & Nephew he said there was “every reason to think long-term growth drivers remain” despite the recent replacement of the chief executive. Both are holds.
Questor says: hold/hold
Ticker: WTB/SN.
Share price at close: £47.79/£18.75½
Update: ISS
We backed ISS, the Danish outsourcing firm, as our tip of the year in 2018 but disappointingly the shares have fallen by 30pc since then.
Richard Pease, manager of the Crux European Special Situations fund, who put us on to the stock, admitted that it had been a “disappointing investment” and that “management have taken their eye off the ball in a few places”.
But he added: “We still hold the shares as this type of business model should be attractive – it is diversified by customer and geography, is capital-light, has a high proportion of recurring revenues and is thus quite stable in a downturn.”
Questor says: hold
Ticker: ISS:DC
Share price at close: Dkr168.65
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