Stocks that offer two sectors for the price of one

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Primark has quadrupled sales in ten years

There are several excellent companies that dabble in two very different markets. Dr Mike Tubbs highlights the ones worth considering now.

Some companies – think Domino’s Pizza – stick to what they do best. Some seek growth by exploring new sectors. On occasion, it goes spectacularly wrong: witness GEC’s disastrous foray into telecoms as Marconi. But sometimes diversifying into another industry boosts overall growth; if the new business is in a defensive sector, it tempers exposure to the economic cycle. One early notable bi-divisonal company was Richard Branson’s Virgin Group, which started as a record shop in the early 1970s but then started Virgin Atlantic Airways in 1984. Before it sold the Costa coffee chain, Whitbread, which also owned the Premier Inn budget hotel chain, was a good example. Google’s shift into self-driving cars is another one, while in the private market, Dyson is adding electric cars to its existing range of airflow products (vacuum cleaners to fans).

Twelve listed stocks with activities in two sectors are highlighted in the table below. They span a wide range of sizes and sectors from food and health to retail and robots, with market values from £200m to $1trn. The new divisions mostly have higher profitability than the original ones and so raise overall group profitability. Five of the 12 companies have health as a new growth sector. One of the advantages of health is that products can usually be patented and must meet strict regulatory standards. Once they are approved, then, potential competitors face twin barriers to entry. Here are the stocks I like most.

Company Original sector(s) New sector Size of new sector* Market cap 19/9/19
Amazon Online retail Cloud computing 13% $899bn
Associated British Foods Food manufacturing Clothing retail (Primark) 41% £18.3bn
Goodwin Engineering Jewellery supplies 34% £249m
Halma Electronics Medical 25% £7.7bn
Johnson Matthey Emissions reduction Healthcare & novel batteries 14.7% £6.1bn
3M Safety, industrial & office products Healthcare 18.5% $96.3bn
Microsoft Office productivity Cloud computing 32% $1.06trn
NCC Software escrow Cybersecurity 85% £523m
Renishaw Metrology Health 7.1% £2.8bn
Smiths Group Engineering & medical Hazard detection 25% £6.6bn
Teradyne Electronic test gear Co-robots 12.6% $9.9bn
Victrex Engineering polymers Health 19% £1.9bn
*New sector sales as % of total sales

Moving to the cloud

Amazon (Nasdaq: AMZN) is well known as the world’s largest online retailer. What is less well known is that it also has a flourishing and highly profitable cloud-computing division called AWS, which contributes 13% of revenue but 50% of operating profits. Cloud computing refers to the lucrative long-term trend whereby companies manage software and data services online rather than in-house. AWS is the world’s most comprehensive and broadly adopted cloud platform which millions of companies use to power their infrastructure. Netflix is just one major AWS customer. AWS is now the clear world market leader with a 32.3% share and 46% annual growth. With a commanding position in online retail and continual investments in new areas of growth, Amazon is likely to make a lot more progress. Its 2020 price/earnings ratio (p/e) of 55 is down from 77 for 2019.

Microsoft (Nasdaq: MSFT) has a virtual monopoly with its office software suite. But its fastest growth, as with Amazon, stems from cloud computing where it is No. 2 behind Amazon with a 16.5% world market share of 22%. Its Intelligent Cloud division accounts for 34% of revenue but 36% of operating profit. Microsoft has recently streamlined its overall business and has excellent management. The p/e for 2020 is 24.

Victrex is worth a PEEK

Victrex (LSE: VCT) is a FTSE 250 company specialising in advanced polymers, particularly PEEK, which is light, strong and resistant to chemicals. PEEK has many applications replacing metals in the automotive and aerospace industries where weight reduction is important. But Victrex also has a healthcare division  – Invibio – which uses the material to supply medical-device manufacturers making products ranging from those involved in joint reconstruction to dental items. Over the last 20 years about nine million Invibio devices have been implanted in patients. Invibio accounts for 19% of revenue but 27% of gross profit.

Victrex has a record of profitable growth although its first-half results reflected weakness in the automotive sector. However, its profitable healthcare division and constant search for new and improved applications of PEEK mean it should return to growth. The p/e for 2020 is 18.4 and it yields 2.8%.

Renishaw (LSE: RSW) is a FTSE 250 company and a world leader in precision metrology with a small healthcare division that moved into significant profit for the first time in 2018. The healthcare business is small, accounting for only 7% of revenue, but grew 15% in 2019 compared with 2018 whereas metrology revenue was down 7.5% because of a downturn in the electronics industry and the US/China trade dispute. The healthcare division makes products including craniomaxillofacial implants, stereotactic neurosurgery and precision dental implants. Although the share price has risen recently it is still down 32% from the 5,650p of mid-2018. The 2020 p/e is 24.

NCC (LSE: NCC) is a FTSE SmallCap firm that originally concentrated on software escrow (whereby a third-party escrow agent holds source code to protect parties involved in a software licence), but which has built up a cybersecurity division accounting for 85% of revenue. But escrow is still the most profitable division with operating profitability of 50% compared with 11% for cybersecurity, although escrow is no longer growing (revenue down 3% last year). NCC has been through a difficult two years, but now appears to be rebounding under a new CEO. The p/e for 2020 is 18 and it yields 2.5%.

Teradyne (Nasdaq: TER) is a long-established US company with a large business in electronic test equipment. Its newer industrial automation (IA) business includes co-robots from its 2015 acquisition of Universal Robots – these are robots designed to work alongside humans as opposed to most conventional robots, which can be dangerous if approached too closely. IA accounts for nearly 13% of revenue and is growing at around 35% a year. Profits are set to grow by 25% in 2020. The stock trades on a 2020 p/e of 19.2.

The ones to watch

The stocks above are the most appealing investment options. There are a couple more that look a tad expensive for now but are worth keeping an eye on. Halma (LSE: HLMA) is a FTSE 100 electronics company with original businesses in safety and environmental protection. It has been building up a new medical division, which is now the second largest, accounting for 25.3% of revenue but 27.7% of profit. The medical division has grown sales at an annual rate of 19% over the last ten years, with profits growing by 20%. Medical products range from diagnostics to ophthalmology. Halma is an excellent company that has raised its dividend by 5% or more every year for 40 consecutive years and continually evolves its portfolio of businesses to maintain a very high return on capital. However, this excellence is in the price and the forward p/e for 2020 is 35 and the current yield 0.8%; it is worth waiting for a lower entry price.

Goodwin (LSE: GDWN) is a British engineering company with interests in mechanical engineering, valves and pumps, and radar antennae. It also has a refractory engineering division supplying the jewellery industry, with major customers in Asia. Refractory engineering accounts for 34% of revenue but 40% of operating profit. Goodwin has been through a difficult period, with revenue down 5% in 2018, but the year to the end of April saw revenue up 2% and operating profits up 37%. But this recovery has been reflected in the share price – up from £19 to £34 in a year.

Smiths Group (LSE: SMIN) has a long-established engineering businesses to which a speciality medical equipment and consumables business has been added. However, the medical business is to be sold or spun-off as a separate company in 2020. Its most recent new business is in hazard detection, supplying the scanners that detect hazardous items such as explosives, weapons, biohazards and narcotics at airports, ports, government buildings and other sensitive sites. Smiths Detection accounts for 25% of both revenue and headline operating profit. Smiths has only shown modest revenue growth in the last few years, however. It may be worth revisiting when it has sold or spun off its medical division since its successful John Crane division (the world’s largest mechanical seals supplier) and hazard-detection division will then form a larger percentage of the group.

Finally, there is Associated British Foods (LSE: ABF), with brands ranging from Kingsmill bread to Ryvita. Its low-cost, fast-fashion chain Primark is the jewel in its crown; it has more than quadrupled sales in the past decade and maintained margins of over 10%. There are now 374 stores worldwide. In recent years the large sugar business has lagged Primark. Some analysts suggest ABF should sell the struggling sugar division or spin-off Primark. If Primark is indeed spun out of ABF it could well be worth investing in.