Goodwin heads for calmer waters

Goodwin (LSE: GDWN), a British engineering firm founded in 1883 that grew rapidly for most of this century, has had a tough time of it in recent years. But the outlook is improving.

Before the oil price crashed in 2014, 60% of the revenue from Goodwin's mechanical engineering division stemmed from oil and gas companies. The manufacture of giant valves used in pipelines, terminals, rigs and tankers is the main activity here.

When customers reduced investment, profitability slumped, but this year's annual report promises a prosperous future, and at the firm's annual general meeting earlier this month the board's confidence was palpable. And the positive outlook is not just based on the rising oil price.

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Preparing for recovery

While fewer orders were flowing through the foundry, Goodwin took the opportunity to install bigger and more sophisticated plant capable of casting even larger products weighing up to 35 tonnes a size that relatively few foundries around the world can match. Goodwin completed the lengthy approval process required to supply the US Navy last year, and has secured the first of what the company believes will be many orders supplying its shipbuilding programme. It is also targeting the US civilian and military nuclear industries, which also require huge high-integrity castings for nuclear reprocessing and propulsion systems.

Goodwin has averaged a return on capital of 9% over the last three years, way below the long-term average, but it could have been worse had it not been for Goodwin's other key division, refractory engineering.

This group of companies mostly supplies minerals for making wax moulds used to cast jewellery. The mass production of relatively low-value silver, brass and gold jewellery is big business in the Far East, where the market is growing strongly and profit margins have been transformed since an erstwhile major competitor, Kerr, stopped selling jewellery-casting powder. Earnings from refractory engineering modestly eclipsed those of mechanical engineering in the year to April 2018.

Oil prices will boost sales

The third factor in Goodwin's likely resurgence is, of course, the higher oil price, which is strengthening the finances of oil and gas companies and should give them the confidence to invest again. Goodwin expects to be doing more oil-related business next year, too, lifting it above the 40% of revenue it currently provides. Thanks to the group's new revenue streams, however, the majority of revenue from mechanical engineering is unlikely to come from oil again. That is probably a good thing, given the rapid adoption of renewable energy.

Growing optimism is reflected in the share price, which has risen sharply since the company reported strong cash flows and a modest increase in profit for the year to April 2018. The share price values the firm at about 20 times adjusted profit on a debt- adjusted basis, but this may be one of those occasions where historic earnings multiples are not particularly revealing. If the company fulfils its promise, relatively low levels of profit in 2016, 2017 and 2018 will be footnotes in Goodwin's financial history.

The Goodwin AGM

Goodwin is run by brothers Richard and John Goodwin, who own the largest portion of the shares. A restricted pool of shares prevents funds buying them in the quantities they require, and they might not want to in any case because the Goodwin family's shareholding gives it control of the company.

Lack of institutional interest means there are no broker forecasts, and few articles in the press, but it also means Goodwin is easily overlooked and may be undervalued. One way for investors to find out more about a company with a low profile is to attend its annual general meeting (AGM). You must be a shareholder to vote, but often firms will allow outsiders to attend and ask questions after the formal business is finished.

I attended Goodwin's AGM as a shareholder, partly to confirm my impression that it is a very well-managed business, and partly to decide whether I can trust the family to act in the interests of all shareholders.

The AGM confirmed my favourable assessment of the firm. Goodwin has earned an average return on capital of 18% over the last decade. It has patents and facilities that mean it can do work few other firms can, and the board says it only takes on high-margin work so profitability should recover.

My one reservation is a pay policy introduced in 2016 that will give each executive director shares worth up to 1% of the total value of the company in April 2019, depending on the performance of the share price.

This represents a transfer of ownership from shareholders to the board, four of them sons of Richard and John Goodwin. Although shareholders' stake will have increased in value by much more than the dilution they will experience if the award is triggered in full, the convoluted nature of the incentive plan has left me questioning the motives of the board for the first time. Its openness and attentiveness to shareholders at the AGM has mollified me somewhat, but before the board puts pay to the vote at next year's AGM I shall petition it to adopt a more transparent policy.