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Bodycote
Heat treatment engineer Bodycote’s 2004 turnover on continuing operations (after excluding those business to be disposed of) was up 4.0% to £426m (+8.5% at CER). Bodycote’s operating profits (before exceptionals and goodwill) was up 14.8% to £54m. These results are largely organic. Sales and operating profits were up across all Bodycote’s business, as were the margins. However, Bodycote’s lager heat treatment businesses’ 11.1% margins is still below the 22% reported in 2000.
Bodycote’s results recovered from the slump in 2002. In 2002 Bodycote’s operating profits fell by 40% to £49m. Bodycote sells services to various industries such as the aerospace market, the power generation market and the oil & gas industries amongst others. The recovery of these markets from the end of 2003, and the restructuring by closing or selling loss making plants increased operating profit. Bodycote is operationally geared, hence the increase in turnover increased profits by a higher percentage, partially offset by the strengthening of the sterling and higher energy costs.
Bodycote’s heat treatment (eg: hardening, annealing, joining of metals, 60% of operating profit) business’s 2004 turnover was up 6.7% with operating profit up 12% at CER. However, in sterling terms, 2004 turnover was up 2.1% while operating profit was up 8.6%. Sales were up as demand increased from the aerospace market and the oil & gas markets. Pricing pressure, and higher energy costs may mean that this business may not achieve the high 22% margin in 2000.
Materials testing business (21.8% of operating profit) sales were up 11.2% and operating profit up 13.3% at CER. This business benefited from an acquisition in the Middle East. Testing needs in the aerospace market, automotive market and the oil and gas industry increased turnover. Increases in wage costs and price pressure reduced the growth in margins.
In 2004, full year sales at Bodycote’s hot isostatic pressing business (12.3% of operating profit, advanced materials technology) were up 23.9% at CER with an improvement (rather a recovery) in margins as were the other operations. Sales increased due to an ‘unexpected’ increased demand for industrial gas turbines. Further increase in industrial gas turbines are not expected in 2005, but will be offset by improved demand for aerospace components. Operational gearing would have helped improve margins.
Higher energy prices will be a concern in the medium term, as is the weakening dollar; this will slow a recovery of margins. Bodycote plans to pass on increase in energy costs to its customers.
Exchange rate fluctuations are another concern. In the first half of 2004, the statement of recognised gains and losses shows the effects exchange rates had on Bodycote. In the first half, a £9.2m profit was wiped out by a negative £9.6m currency adjustment. However this could go both ways, as currency adjustments added a positive £2.9m by the end of 2004 increasing the total recognised gain to £21.6m.
Bodycote shares trade at a prospective PE of 14.1× (at 181.5p) at the higher end of the range for the sector. The 3.5% yield is in line with the sector. The 2004’s free cash flow per share of 17.8p is greater than the 11.3p EPS reflecting good cash generation.
The planed disposal of loss making subsidiaries will increase reported profits (the numbers we discussed above excludes the planned disposal). Profits will be further enhanced by the contribution of acquisitions. The rights issue in 2004 strengthened the balance sheet and as will planned disposals put Bodycote position to make acquisitions (which it plans). Both Bodycote’s track record and its announced plans have been for small bolt-on acquisitions so we do not view this with concern. The major risk (both the upside and the downside) to the stock stems from the effects that the cyclical nature of Bodycote’s services combined with the operational gearing have on results.
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