Questor: yes, steam engineering really is hi-tech – and this UK business is a world leader

A steam engineer sounds like a business whose heyday came in the railway mania of the 19th century, but such a company very much has a place in the economy of the 21st century – and a British firm leads the world in this forgotten but important corner of modern industry.

That firm is Spirax-Sarco, a member of the FTSE 100, and we feature it today as one of two businesses admirably placed to deal with investors’ current bête noire: inflation.

As we often say, a company’s best defence against inflation is pricing power. It can come from brands, as we said yesterday in connection with PZ Cussons, owner of Carex and Imperial Leather, or from having a monopoly or near monopoly in the supply of goods or services that customers cannot do without.

Steam, as we said, still has a wide variety of uses, from the safe sterilisation of food to the generation of power, and handling it requires special equipment and expertise.

“Spirax-Sarco is a world-class engineer,” said Richard Hallett, who runs the Marlborough Multi-Cap Growth fund. “It’s a class act. Why is it different? It has 60 years’ experience and can deal directly with its industrial customers thanks to its 1,900* or so specialist engineers around the world. No rival can offer this – other firms tend to use distributors.

“Spirax-Sarco’s direct relationships allow it to offer much better availability of parts as well as consultancy services. Its products are more expensive but that combination gives it real pricing power. It helps that the value of its goods and services is small compared with the sums tied up in its customers’ plant. Hence it has a record of being able to nudge up prices year after year.” 

Away from steam, the company also supplies “peristaltic” pumps, which work by squeezing fluids along pipes. This means no contact between the pump and the fluids themselves – important where contamination must be avoided, as in drug factories.

Readers will be, by now, well used to the connection between pricing power and high margins, returns on capital and cash generation, and Spirax-Sarco does not disappoint in these respects.

“It has 30 years of continuous growth, well spread around the world, behind it. It’s always reinvesting, but it produces plenty of free cash too,” Hallett said. “When you talk to management it is all about the long term, protecting its culture, looking after its customers, investing in intellectual property. It’s not cheap but it’s a lovely business.” 

Questor says: buy

Ticker: SPX

Share price at close: £138.05

*Amended from 500-plus in version originally published

Smart Metering Systems

This company, which installs and owns the smart meters that send gas and electricity consumption data straight to utilities, has an even more direct way to protect its revenues from inflation: they are explicitly linked to the retail prices index.

“Meters used to belong to the gas and electricity companies but SMS actually owns the meters it installs and charges the utilities rent, which currently amounts to about 11pc a year of the value of the meters,” Hallett said. 

“It typically has 20-year contracts and this security of income allows it to borrow cheaply to fund its assets. The gap between that 11pc return and the cost of the debt is its profit. As it grows – and it has a pipeline of 2.5m meters yet to be installed – its borrowing costs should fall.

“Those installation contracts mean it can guarantee at least a 10pc rise in its dividend each year until 2024, after which one of two things will happen: either it will stop growing, which would mean its revenues rise in line with the RPI but it will be able to cut costs as it will no longer need its installation teams, or it will continue to grow and offer scope for faster rises in the divi.”

It makes 90pc of its money from meters but is diversifying into other energy-related assets such as battery-based backup for the grid. The shares yield about 3pc and the dividend is covered about 1.6 times by cash flow.

“We’ve known this business for more than 10 years and it scales very nicely,” Hallett said. “It’s been very successful and it has a resilient business model not at all geared to the economic or business cycle. The shares have gone up a lot but we think it still looks rather cheap.”

Questor says: buy

Ticker: SMS

Share price at close: 876p

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