IMI is a global engineering group focused on the precise control and movement of fluids in critical applications and comprises five platform businesses - Severe Service, Fluid Power, Indoor Climate, Beverage Dispense & Merchandising. I have a holding in my income portfolio (epic code: IMI).
IMI released their interim results on Friday and were yet another international company affected by the strength of Sterling on translation of their results. Revenues were up 3% on an organic basis to £808m, but declined by 2.9% on a reported basis.
Before exceptionals (mainly impairment charges), operating profit was down -7.1% to £135.7m and on a reported basis down -12.8% to £112.6m. Adjusted EPS for the continuing businesses was 34.5p up 10.2% and on a reported basis 29.4p up 6.5%.
The company completed the disposal of its Beverage Dispense and Merchandising divisions on 1 January 2014, realising an exceptional profit of £478m. Following the disposal, the Group returned £620m of cash to shareholders accompanied by a share consolidation of 7 for 8.
Free cash flow was £41.2m for the six months, compared to £95.1m last year. The disposal mentioned above also generated £662.6m of cash and settlement of derivative contracts generated cash of £23.2m; from these amounts and the FCF, £620.3m was returned to shareholders, a one-off payment to the UK pension fund of £53.2m was made and dividends of £60.6m paid. This resulted in an increase in the net debt position from £225.9m at the year end to £231.8m at 30 June.
Management have stated that "...based on this first half performance and an expectation of improved revenue momentum in the second half, the Board has decided to increase the interim dividend by 6.25% to 13.6p..."
In commenting on the longer term prospects management state that "...the opportunities are significant and that is reflected in our ambition to double the Group's 2014 operating profits over the next five years, while retaining our financial discipline..."
Critical Engineering (Severe Service) - market size £6.7bn, estimated growth 6.4%, share 9.8%
Precision Engineering (Fluid Power) - market size £13.5bn, estimated growth 4.3%, share 5.3%
Hydronic Engineering (Indoor Climate) - market size £2.4bn, estimated growth 5.1%, share 12.8%
To double their operating profits by 2019 will require compound growth of just short of 15% pa. To achieve this will require the company to increase their market share either organically or by acquisition, since their return on sales in most sectors they operate in are amongst the best in the market, leaving little leverage there.
Initially there will be some strain on the operating profit as they intend to progressively increase R&D from ~3% of sales to 4-5% and progressively increase capital expenditure to 2x depreciation (currently ~1.2x).
If we assume that the 15% growth over the next five years comes equally from market growth, increased share by organic means and the remainder by acquisition, then I make the total spend on acquisitions likely to be £0.5bn over the next five years. This can be comfortably achieved within their own resources, since they state they are prepared to accept a net debt/EBITDA ratio of 2x (currently ~0.7x).
IMI operate in thirteen market sub-sectors and are market leader in just two and have a double digit share in just five sub-sectors, so there should be opportunities for market share growth both organically and by acquisition.
Importantly management have stated that their capital allocation priorities are:
- reinvest for organic growth
- progressive dividend policy
- acquisitions to supplement organic growth
- return excess capital to shareholders
IMI at 1445p is not a cheap share at 15x expected 2015 earnings and offering just 2.85% as a prospective yield, but if they achieve their 5 year targets with internal resources, then any price below 1600p might be considered good value.
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