A Growing 5% Yield Up For Grabs

Published in Company Comment on 30 August 2011

This internationally expanding niche engineer is on a low valuation.

If you feel like a kid in a sweetshop with all these cheap shares about, I don't blame you, so do I.

However, before splurging all our pocket money on bargains, let's make sure we are in the right sweetshop. We don't want to go buying cheap, poor quality sweets when the best and tastiest are on sale at the posh shop down the road. It's far better to have them.

So it is with shares. If we are buying cheap shares, let's make sure that they have the hallmarks of quality, like:

  • good forward growth prospects;

  • modest debt with a record of debt reduction;

  • a good trading record, especially through the recent economic austerity; and

  • value characteristics like a low PER, asset backing, high, well-covered yield etc.

One company that seems to possess all these attributes is Hill & Smith Holdings (LSE: HILS), which describes itself as 'an international group with leading positions in the design, manufacture and supply of infrastructure products and galvanizing services to global markets.'

Galvanizing the world

The company designs, manufactures and supplies stuff like road safety barriers, street lighting columns, bridge parapets and gantries, as well as zinc and other coatings. Business has been going well in recent years, with just under 70% of it now coming from overseas.

It has been focussing on costs and positioning itself for growth with acquisitions and divestments. For example, it acquired a US business this year that has an established position supplying pipe supports to the North American nuclear power industry -- a good fit with its existing pipe support business.

In another deal, it sold a business, saying that the disposal completed a repositioning away from building and construction activities, enabling a focus on higher margin infrastructure products and galvanising services.

Maintaining profits

Judging by the figures, the strategy seems to be working well:

 20062007200820092010
Revenue (£m)306330420390374
Operating profit (£m)1833434540
Diluted earnings per share19.3p29.1p29.7p35.9p31.7p
Dividend7.2p8.7p10p11.5p12.7p
Net cash from operations (£m)412375738
Net gearing60%122%124%67%46%

Despite what it describes as 'challenging trading conditions,' the business has managed to turn a profit over the last few years, whilst increasing the dividend and reducing its debt. Although debt has increased recently to finance acquisitions and now produces a net gearing figure of 76%.

It's encouraging to see that the progressive dividend policy has been backed up with cash flow that has been holding up reasonably well.

Recent guidance

Hill & Smith released its interim report on 8 August showing that revenue was up by 0.8% on the equivalent period last year, but operating profit was down nearly 23%.

The directors said that trading was within their expectations and that operating margins had been affected by 'highly competitive market conditions and rising material costs.' They went on to say that there is a strong order book for the second half but they are 'cautious given the difficult economic and competitive pressures.'

So it seems that trading is tough, but that hasn't stopped the directors raising the dividend by 4%; a move that seems to suggest confidence that trading conditions will improve. Indeed, analysts are forecasting a 13% lift in earnings per share for 2012.

Valuation

In Hill & Smith, we appear to have a company that has been reshaping its business by cutting the deadwood and focussing on lines, and markets, with more attractive margins. In fact, return on capital employed has been running at a healthy-looking 25% or so for several years.

It has been steadily building its overseas revenues and these now constitute the majority of its turnover. In general, the company seems poised for further growth in the medium-term. If the valuation is attractive, perhaps short-term headwinds are providing investors with a buying opportunity now.

The share price is 268p as I write, valuing the company at around £206m, and putting it on a price to book value of about 1.4. At this level, the shares are on an almost three times covered forward yield of 5.2% and a forward price to earnings ratio of about seven for 2012, according to analyst's estimates.

All of this compares well with some of its industrial engineering peers, like Bodycote (LSE: BOY) yielding 4.3% and on a P/E of 8 for 2012, Castings (LSE: CGS) yielding 3.8% on a multiple of 11, and Fenner (LSE: FENR) with its 2.9% yield and forward P/E multiple of 11.

Bottom line

To me, Hill and Smith looks like a good business with a strategy for international growth. It appears to have been making well-targeted acquisitions to help it focus on higher margin business areas.

Trading is tough just about everywhere right now, but that may be just the time to pick up the shares cheap. They are, at the very least, worthy of further research.

More from Kevin Godbold:

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