Small UK industrial stocks are hidden gems

At Odyssean Investment Trust we seek to invest in high-quality UK businesses trading below their fundamental value, with scope for that value to grow through proactive management action. One area where we have been active recently is an unglamorous part of the market: British small-cap industrials.

The UK industrials sector is overlooked and unloved. Investors often conflate “industrials” with visions of grubby metal bashers serving a diminishing manufacturing base. In truth, this sector is highly diverse, and for those prepared to look, you can find a number of first-rate, globally-focused businesses with exciting growth prospects.

To find the gems in industrials, we look for three key attributes. First, the most attractive companies utilise their own intellectual property in their products or production processes, allowing them to be global leaders within a niche. Expertise that is hard to replicate creates a significant economic moat to underpin any investment.

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Second, while industrials can be cyclical, many companies enjoy exposure to long-term growth megatrends such as AI spending, renewables investment or growing demand for healthcare. Short-term swings can often hide longer-term secular stories, offering opportunity for the patient investor.

Finally, industrials businesses can be complex: managing production, ongoing research and development (R&D) and an evolving demand environment are not easy. High quality management can add significant value; backing proven, experienced teams is crucial.

Three British industrial stocks that are powering profits

XP Power (LSE: XPP) fits our criteria nicely. The business is a leading designer and manufacturer of power supplies that enable high-technology applications across industrial, healthcare and semiconductor end markets. It uses its world-leading expertise to design power supplies that meet the needs of the most demanding cases.

The group has a strong track record across the cycle, benefiting from growing demand for semiconductor-manufacturing capacity – a trend set to continue given current geopolitical and AI demand drivers. Led by a proven team who have delivered strong operational control through the recent cyclical downswing, this stock’s long-term potential is overlooked by the market.

Another emerging UK industrials champion is Xaar (LSE: XAR). The company manufactures ink-jet printheads with unique technology that allows the deposition of high viscosity fluids at high accuracy for a range of industrial applications. Based on intellectual property developed over many years, the group’s print heads are sold globally and are the core component of its customers’ printing machines.

The group is active in a number of sectors, but under its current leadership has recently used the unique abilities of its technology to open up markets previously unaddressed by ink-jet deposition solutions. These new opportunities offer a route to long term growth regardless of shorter-term market cycles and, we believe, herald an exciting future for the company.

Another UK-based industrial with a niche, global leadership position is Dialight (LSE: DIA), a leading provider of LED lights used in hazardous industrial environments. The group’s design expertise allows it to offer industry-leading reliability, critical for the extreme, niche-use cases it serves.

LED lighting continues to gain share from traditional alternatives given its higher reliability and lower power usage, providing a tailwind of growth for the group across economic cycles. After a tough period, Dialight has been rejuvenated in recent years under a new leadership team with proven experience of driving value at industrial businesses. We believe it is one more of the gems in UK small-cap industrials.

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