UK Edition
Questor: keep it simple? In Johnson Matthey’s case, complexity brings great opportunity
It was Peter Lynch who advised investors never to put money into any idea that couldn’t be illustrated with a crayon, but one fund manager disagrees. “Complexity can offer opportunity,” Sue Noffke of Schroders told Questor.
The stock she had in mind was Johnson Matthey, the speciality chemicals group, which she has recently added to her Schroder Income Growth fund.
“Even the catalytic converter division has a lot of moving parts and there are another three divisions,” she said. “It takes a lot of effort to analyse a business of this sort and many investors don’t bother, so it can be a way to discover hidden value.”
Noffke said each of the company’s three main areas of business – the others are vehicle batteries and pharmaceuticals – was poorly understood by the market. Johnson is one of the world’s largest makers of catalytic converters and investors who have tried to value this part of the business have “focused on the death of diesel in Europe and not understood the opportunity internationally”, the fund manager said.
“Different elements, partly from China and the US, will combine to keep profits up,” she added. “Europe will peak in the next couple of years in terms of Johnson’s profitability in smaller vehicles, but in trucks it’s more complex.”
There is also a more nuanced picture in America. “Diesel cars are not popular in the US but the market for diesel trucks, such as SUVs and pickup trucks, is much larger and Johnson Matthey’s expertise in diesel catalysts together with strong ongoing consumer demand bodes well for future sales. We’ve tried our best to model all of this but uncertainty has weighed on the division’s valuation.”
As far as the firm’s battery arm is concerned, she said Johnson was investing to make it a “significant business”, adding that its products offered “exciting opportunities” to carmakers. “But its technology is new and has risks as well as potential. I don’t think it has been properly priced by the market,” she said.
It’s a similar story in the pharmaceuticals division, which sells specialist metals to drug makers.
“More investment has gone into this business and it has been restructured, bringing about lower manufacturing costs,” the fund manager said. “Johnson believes it has exciting products and could improve profits here from £50m to £100m or £150m over the next three years or so. But investors have seen profits decline in this division up to now and have not appreciated the extent of the turnaround.”
Noffke paid about £33 for her Johnson Matthey shares (they are now nearer £37) and said she would buy more if they went below £35. “They would need to reach £50 before I saw them as overvalued,” she said.
- Read Questor’s rules of investment before you follow our tips. See Questor's tips every day at twitter.com/DTquestor
The shares currently trade at about 17 times forecast earnings. The dividend has been growing at a mid to high single-digit rate. “We try to find stocks that have potential from a recovery or because there is an overlooked nugget of a good business or because the market is failing to spot opportunities to grow,” Noffke concluded.
“Johnson Matthey has all of these across its different parts, although our investment case doesn’t depend on all of them coming good.”
The company was also identified as one of the most promisingly positioned in new battery technology in an extensive report on the subject published recently by Berenberg, the investment bank.
Questor says: buy
Ticker: JMAT
Share price at close: £37.25
Update: Kromek
Last week we quoted Gervais Williams of Miton in connection with two Questor holdings, Motorpoint and IG Design, but lacked space to include his latest views on Kromek, the advanced scanner firm, tipped in March last year, that has failed so far to deliver for this column.
Williams said: “The investment case remains intact – there haven’t been any other technologies that have displaced Kromek’s, but I did expect much greater orders by this date. We made our call too early but we haven’t sold a single share.”
Questor says: hold
Ticker: KMK
Share price at close: 22.25p
- Questor archive: telegraph.co.uk/questor