Shares in focus: Bucking the trend in British manufacturing

The shares aren’t cheap, but Senior is a quality company worth tucking away, says Phil Oakley.

A symptom of Britain’s economic woes highlighted by commentators over and over again is the decline in manufacturing. There’s no disputing the fact that lots of heavy industry, such as shipbuilding, has gone elsewhere.

It’s also true that the share of manufacturing in employment and gross domestic product has fallen steadily since the 1960s. Still, not enough is said about the good manufacturing businesses that are still here.

The FTSE 250 index is home to many successful British engineering firms that are doing very nicely. Instead of playing in commoditised markets where all that seems to matter is a low price, they focus on highly specialised, value-added engineering that commands higher prices and is more difficult to compete with.

Hertfordshire-based Senior is a good example of this trend. It is an international manufacturing group with operations in 13 countries and has a significant number of its factories in Britain. It makes high-quality parts that are used in aircraft and vehicles, with the bulk of its sales revenue coming from North America.

Its shares have been on a storming run since the dark days of 2009, largely due to the booming commercial aerospace markets. Can the good times continue?

How the business has fared

Looking at Senior’s share price chart it’s not difficult to come to the conclusion that the easy money has been made. It’s true that the shares are not distressed or in bargain-basement territory, but that doesn’t mean that they can’t deliver decent returns to investors in the years ahead.

Whether they can or not will be largely dependent on the company’s aerospace division, which accounts for just under two-thirds of total profits. Here Senior gets the bulk of its income from selling to commercial aircraft firms such as Boeing and Airbus, or to engine makers such as Rolls-Royce. It also sells into the military aircraft market and to the makers of business and regional jets.

Boeing and Airbus have record order books as the world’s airlines look to invest in more modern, fuel-efficient aircraft. If Senior is to grow its profits, then Boeing and Airbus have to increase their production rates.

This is their plan, with Boeing looking to increase the production of its 787 Dreamliner from seven aircraft per month in 2013 to 12 per month by the end of 2016. This would be good news for Senior, given it sells £500,000 worth of parts on each 787 and £250,000 on each Airbus A350.

There is also a good chance of securing new orders of updated versions of the A320, the A400 military planes and Bombardier’s C Series passenger plane, which is targeted at the regional jet market. Orders for this plane have been growing steadily and now stand at over 200.

Senior currently expects to sell parts worth around £300,000 on this aircraft, paving the way for £60m of extra sales. The first delivery is expected in 2015. Senior is also expanding its manufacturing capacity in Thailand to capitalise on growth in the Asian aircraft market.

Turbulence ahead?

All this sounds very promising, but should not be taken for granted. The aircraft market is highly sensitive to changes in the global economy. Sharp downturns after the September 11th terrorist attacks on America and the financial crisis in 2008 saw airlines cancel orders for new planes, and this inflicted a lot of pain on suppliers such as Senior.

Aircraft builders are also bearing down on costs, which means that Senior’s profit margins are likely to shrink slightly – although if build rates increase, profits should still grow.

Elsewhere, Senior has a business called Flexonics, which sells products into the North American heavy truck and European car markets. This business should do all right over the medium term, as Senior’s key products are focused on reducing vehicle emissions, an area where regulations look set to get tougher.

At the moment, demand for heavy trucks is lacklustre, while the European car market is flat on its back. Demand should pick up over the next few years as and when economies improve.

Should you buy the shares?

Senior’s businesses seem to be underpinned by decent fundamentals. What’s encouraging though is that it also has many of the hallmarks of a quality business.

As I’ve said many times before, it pays to invest in good businesses that are capable of earning high returns on the money they invest. (Check out page eight for a detailed strategy of investing in this type of company.) With a return on capital (ROCE) of 26% during the first six months of 2013, Senior passes this test with flying colours.

Senior also seems to be good at turning a high proportion of its profits into cash. This allows the company to pay higher dividends, fund investment in the business and get rid of debt. Not that debt is a problem at all.

Gearing (debt as a percentage of shareholders’ funds) is a modest 18%, while interest payments are covered ten times by operating profits. City analysts expect the company to be debt free by the end of next year.

Profit growth should be reasonable, although the value of the pound against the American dollar might have an impact on this. Given that Senior has a lot of its business billed in US dollars, the weakness of the dollar against the pound has held back profit growth recently (because Senior needs to earn more dollars to produce a pound of profits).

Analysts expect profits growth of around 7% in 2014, increasing to 9% in 2015. With the shares trading on 15 times 2014 expected earnings, they are not cheap, but if the aerospace markets stay buoyant then paying up for this quality company could make sense for long-term investors.

Verdict: long-term buy

Senior share price chartSenior (LSE: SNR)

Share price: 299p
Market cap: £1.24bn
Net assets (June 2013): £351m
Net debt (June 2013): £65.5m
P/e (prospective): 15.1 times
Yield (prospective): 1.9%
Dividend cover: 3.5 times
Interest cover: 10.0 times

Senior dividends per shareWhat the analysts say

Buy: 9
Hold: 4
Sell: 1
Target price: 305p

Directors’ shareholdings

M Rollins (CEO): 750,000
D Harding (CFO): 20,000
C Berry (chair): 10,000