UK Edition
Questor: buy Weir as its recent deal doubles expected profit growth for the next five years
A minor tremor shook Glasgow in April. Weir Group, which is headquartered there, announced its largest acquisition to date and simultaneous plans to offload a division that accounts for a sixth of its sales.
It is not the first time the 147-year-old company has remade itself. Its historic Cathcart works in the Scottish city were sold just over a decade ago and the latest plan will see it completely move out of pumps and valves used in power stations and water treatment plants.
Weir is effectively trading in its low-margin flow control division for a bigger prize. Spending $1bn (£760m) on Esco, a maker of mining equipment based in Portland, Oregon, is boss Jon Stanton’s way of digging deep for mineral wealth.
Completed two weeks ago, the Esco deal increases Weir’s mining exposure to two thirds of operating profits; the remainder comes from oil and gas. The company already provides conveyor belts and crushers to the mining giants but Esco’s extraction kit that tears into rock, among other “ground engagement”, will move it along the supply chain and presents a chance to cross-sell.
It is an opportune point in the cycle to be expanding. Miners’ capital expenditure is forecast to continue rising for several years. BHP Billiton recently set a record for annual iron ore output and posted a higher target for this year. Copper and coking coal were highlights for Anglo American.
Mineral industry suppliers trade on a higher multiple than those serving oil production to reflect slightly lower volatility. Analysts at UBS, the bank, forecast group underlying earnings for Weir to grow at an 18pc compound annual rate for the next five years, versus 8pc in its previous model.
As with any company exposed to the resources industry, the recovery in Weir’s shares since early 2016 has been impressive. The price has more than doubled from the trough but has largely tracked sideways for the past year, suggesting that most investors are asking themselves “where next?”.
- Reader Service: Manage a range of investments through a single online platform with AJ Bell Youinvest
Recently, any excitement that Esco will power up earnings has been tempered by what is going on 4,500 miles away from Glasgow.
The Permian basin in west Texas is the home of the shale oil revolution. It has been pumping out so much of the black stuff that it is expected to surpass Opec members Iran and Iraq next year. However, for the time being there is a lack of pipeline capacity so producers are limiting production and deferring new fracking. This means a temporary fall in demand for Weir’s pressure pumps, prompting earnings expectations to be trimmed for this year and next by around 4pc.
Analysts at Citi, another bank, point out that Permian represents 12pc of group revenues. They believe Weir management will at least maintain guidance for its oil and gas activities alongside interim numbers due on Tuesday. In fact, the bank has raised forecast growth rates for 2020 from 10pc to 14pc for its pressure pumps, as producers play catch-up.
- Read Questor’s rules of investment before you follow our tips. See Questor's tips every day at twitter.com/DTquestor
It is worth remembering that worldwide fracking activity is outpacing the equipment available. This is a high-quality problem, arising in the midst of a modern-day gold rush.
More broadly, the outlook for the oil price is as ever pegged to the global economy. Analysts have been trying to divine signs of an impending slowdown from the latest crop of Wall Street corporate data but it has not been conclusive. America is still powering ahead, helped by Donald Trump’s one-off corporate tax cuts. Some experts argue that a surge in the oil price is due before the next dip develops.
For now, improving profitability on all fronts will help Weir pay down the debt associated with the Esco deal in no time. It is too early to expect the company to have found a buyer for its flow control division, which was losing money not so long ago, but it should raise £250m in time.
- Questor archive: telegraph.co.uk/questor
Then Stanton, who was finance director before he stepped up to run the company in 2016, can resume Weir’s steady flow of smaller, bolt-on deals.
For next year, when the Permian logjam should have alleviated, the stock trades on an undemanding 15 times forecast earnings. Some analysts have pencilled in target prices 25pc higher than today’s level.
Questor says: buy
Ticker: WEIR
Share price at close: £19.40