Spectris Update

Spectris issued a profit warning on 19th June indicating that sales/EBITA will be £15m/£10m lower than expected in H1 2024 due to weaker-than-expected sales in China, a significant decline in battery development as EV sales slow, and ongoing subdued Pharma demand. These headwinds are expected to continue in H2. Management also highlighted that the roll-out of a new ERP system would delay the execution of some orders, resulting in £15m/£10m sales/EBITA falling into H2 rather than H1, with no full year impact. 

Based on initial broker reports, the downgrade to consensus earnings will be c8%/c7% for 2024/2025, broadly in line with the c-8% share price decline since the announcement. The shares are trading on 15x forward earnings, at the lower end of the 13x-25x 10 year range – despite, in our view, being a stronger business than it was several years ago thanks to portfolio evolution over recent years. Based on our Cash Flow Return on Investment (CFROI) valuation method, the primary valuation tool we use for all stocks in the Evenlode universe, Spectris’ shares look more attractively valued following the profit warning, and are now in the upper quartile for the Evenlode Income universe (i.e. in terms of ranking by implied total return backed out from the CFROI forecasts). The CFROI analysis projects cash generation over the medium and long-term. We have not changed the key assumptions following the profit warning -  through-cycle cash return on assets, delay period and medium/long term growth rate – as we believe these remain appropriate. 

As well as being attractive from an absolute perspective, it is also interesting to note the valuation discount that Spectris currently trades on relative to its global peers (compared to Spectris’s PE of c15x, its UK peer group trades on about 18x and its global peer group on about 28x). 

Spectris is a 2.4% position in the Evenlode Income portfolio, and we have set a maximum position size of 3%, which is driven by Spectris’ scores, from A to E, across 10 key fundamental risk factors. In particular, Spectris has a strong competitive position in measurement technologies (Moat B), serves markets with long-term structural growth potential such as life sciences and semiconductors (Long-Term Industry Outlook B), but also has a higher level of economic sensitivity (D), with the majority of revenue from relatively large ticket instrument sales. The other risk scores include pricing power, economic sensitivity, cash generation, balance sheet, management and culture, ESG and liquidity. We do not think management changes announced on the same day, with the current CFO, Derek Harding, moving to President of Spectris Scientific, Spectris’ largest division, are related to the weaker trading in the first half. We expect this change relates to long-term CEO succession planning. The weakness in trading in the first half has not materially changed our thinking around the risk scores or maximum position for Spectris. 

Putting this all together, prior to the release Spectris’ shares had underperformed year to date, and we did think they were starting to look more attractive on valuation. However, we had not materially added to the position as other stocks within the portfolio were more attractive on valuation, taking into account quality and growth, and we were slightly cautious on the pick up in demand required in the second half to meet full year expectations. Last week’s announcement, and the consequent reduction in consensus earnings estimates, has de-risked the latter concern somewhat. On balance therefore, we may look to add to the Spectris position..