Share tips: Pick up this unfairly battered steel-mill supplier
Paul Hill Oct 26, 2012
Global GDP and steel demand seem to be joined at the hip. The recent economic slowdown triggered an 11% drop in European steel output in July and August. Destocking has added to the pain by hitting US and South American volumes. This has damaged Cookson – the world’s leading supplier of heat-retardant ceramic pipes, valves and container linings used in foundries and steel mills.
The company was forced to issue a profits warning on 8 October, thanks to a second-half-year performance that will be materially below expectations. But I think the gloom has been overdone.
For starters, the economy is not falling off a cliff – the European Central Bank’s promise of “unlimited” bond buying has removed some of the recent fear. Trading at Cookson’s two units providing niche consumables for the electronics (29% of sales) and precious metals (11%) industries remains on track.
And net borrowing is set to fall significantly, from £461m at June, to below £400m by the year end – representing a comfortable debt to equity level of around 1.3 times earnings before interest, tax, depreciation and amortisation (EBITDA). This should give the firm enough scope to maintain a 4% dividend yield alongside dividend cover of three times.
The board has responded promptly to the temporary slump by imposing a hiring freeze, axing agency staff and cancelling overtime. One of the group’s two solar factories in China is being shut. Should the backdrop deteriorate further, more cost-cutting measures will be implemented.
The recent profit warning should not stop the board from demerging its rapidly expanding electronics arm. This unit supplies all the solder for Apple’s iPhone and iPad, as well as for other tablets and smartphones. A demerger should unlock value by removing the discount attached to the shares when compared with a sum-of-the-parts valuation.
Cookson (LSE: CKSN), rated a BUY by Panmure Gordon
The City is forecasting 2012 turnover and underlying earnings per share (EPS) of £2.57bn and 68p respectively, nudging up to £2.62bn and 72p in 2013. The stock trades on a p/e of just 8.1, which looks far too cheap for a science-orientated business with entrenched market positions. Its products are critical to the quality and efficiency of its customers’ manufacturing processes, and also represent only a small part of their total cost.
Given all this, I would rate the company on a nine times EBITA multiple, which, adjusted for net debt and a £81m pension deficit, generates an intrinsic worth of about 625p a share.
There are a few risks to watch for, including changing raw materials prices and foreign-exchange fluctuations. But these are more than baked into the share price. Panmure Gordon has a price target of 680p.
Rating: BUY at 550p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments. See www.moneyweek.com/PGI or phone 020-7633 3634 for more information.
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