Turkey of the week: an overpriced platinum stock

published 10 October 2007

Johnson Matthey is a speciality chemicals firm focusing on platinum. The business is organised into three units: environmental technologies, precious metals and pharmaceutical materials, all of which revolve around the white metal. Its main activities include the manufacture of catalytic converters for pollution control, platinum trading and research into platinum-based cancer drugs.

Turkey of the week: Johnson Matthey (JMAT), rated as OUTPERFORM by Bear Stearns

Current market conditions couldn't be more favourable. Higher platinum prices are boosting its trading activities, while stricter emission standards are driving demand particularly for the company's heavy-duty diesel catalysts. Platinum is used to filter out carbon monoxide and particulate matter from vehicle and engine exhausts. In other words, Johnson Matthey is making hay while the sun shines. Nonetheless, as a value investor I consider the stock overpriced, especially as there are substantial risks ahead.

Firstly, the precious metals division, which benefits from rising platinum prices, has recently been the main-stay of profit growth. Johnson Matthey's underlying operating profits have jumped 26% over the past two years, but a whopping 64% of this has come from this unit. This is a concern because its profits are volatile and would be hit if the platinum price was to soften from its current record levels.

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Next, it is worth noting that since Johnson Matthey has "bet the house" on platinum its earnings would be badly affected if substitute materials or superior technologies that reduce the need for the metal were to be developed. Only on Monday, Japan's Mazda reported that it had developed the world's first catalyst for cars that would slash platinum and palladium use by 70%-90%. This follows on from July's news that Nissan has also developed new technology that could halve the use of precious metals. And many other research institutes, such as Oxford Catalysts, are investing heavily in this area. If I was a shareholder, I would be concerned about the sustainability of Johnson Matthey's platinum science in the medium to long term.

With regard to valuation, the shares, like the metal, are undoubtedly not cheap. The City is forecasting earnings per share for this year and next of 88p and 100p respectively, putting the stock on toppy p/e ratios of 18.9 and 16.6. I would value the stock on a 14-times multiple, or around £12.30 taking account of the precious metals unit's lower-quality earnings stream and the falling operating profit margins in its catalysts business.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.