On this theme, one area where we have been active recently is an unglamorous sector in an unloved part of an undervalued market: UK small-cap industrials. We think the sector hides a number of gems.
Within industrials we look for firms with know-how in complex production processes that is hard to replicate, as this offers the opportunity for pricing power and attractive margins. We like companies with a global customer base, reducing reliance on the UK economy and increasing the potential appeal to overseas investors and acquirers.
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Finally, we like to back proven management teams with a clear plan. We have found a number of such opportunities, which is why industrials is currently our largest sector exposure.
A big blue-chip client base
One of our more recent investments has been Gooch & Housego (LSE: GHH), a leading manufacturer of photonics and electro-optics solutions selling to a blue-chip client base of healthcare, industrial and aerospace customers around the globe.
The group’s end markets are growing strongly, and G&H is well-placed with unique capabilities in optical coatings and materials.
Having historically been built up through mergers and acquisitions, the group recently appointed a new CEO, who is focusing on boosting margins significantly by integrating historic deals better.
Today the stock is on an enterprise-value/sales (EV/sales) ratio of around one, compared with a ten-year average of 2.2. We feel the market is giving little credit to the growth and improvement potential in a group with world-leading intellectual property (IP).
Another more recent addition to our portfolio is James Fisher (LSE: FSJ), a leading provider of marine services and technical products to the offshore- renewables, energy and defence sectors.
The group covers a range of specialist niches where its engineering expertise is crucial, from building offshore wind farms to submarine rescue services.
The group serves global markets with secular growth drivers and often provides unique products or services. Having had a troubled period after the pandemic, the group now has a new CEO with clear plans to drive improved performance across margins and return on capital, a key gauge of profitability.
The shares trade at around book value, which we see as undervaluing the expertise and quality in the group’s varied business units.
Chemring’s wide moat
Finally, we see potential in Chemring (LSE: CHG) a leading provider of countermeasures, sensors and energetics products primarily for the defence industry.
The group enjoys unique IP. It is among the few players globally capable of manufacturing its energetics products; it is an incumbent provider of high-end sensor products on several large US defence platforms; and within the group there is a high growth cyber-security consulting business (Roke), which has world-leading expertise in electronic warfare and cyber defence.
The global reappraisal of defence priorities following the Ukraine war supports ongoing favourable demand and we see the group as well placed to deliver strong earnings momentum from here. On an EV/sales ratio of 1.6 the value of the group’s expertise and its future market demand is, in our view, being overlooked.
Rupert is the Deputy Digital Editor of MoneyWeek. He has been an active investor since leaving school and has always been fascinated by the world of business and investing.
His style has been heavily influenced by US investors Warren Buffett and Philip Carret. He is always looking for high-quality growth opportunities trading at a reasonable price, preferring cash generative businesses with strong balance sheets over blue-sky growth stocks.
Rupert was a freelance financial journalist for 10 years before moving to MoneyWeek, writing for several UK and international publications aimed at a range of readers, from the first timer to experienced high net wealth individuals and fund managers. During this time he had developed a deep understanding of the financial markets and the factors that influence them.
He has written for the Motley Fool, Gurufocus and ValueWalk among others. Rupert has also founded and managed several businesses, including New York-based hedge fund newsletter, Hidden Value Stocks, written over 20 ebooks and appeared as an expert commentator on the BBC World Service.
He has achieved the CFA UK Certificate in Investment Management, Chartered Institute for Securities & Investment Investment Advice Diploma and Chartered Institute for Securities & Investment Private Client Investment Advice & Management (PCIAM) qualification.
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