Targeting largely defensive and highly regulated niches, Smiths Group (SMIN) has created a virtuous circle of high barriers to entry and increasing market share. Better still, it is in the middle of a transformation capable of adding millions in value for shareholders.

Smiths’ calls itself a ‘pioneer of progress’ with a diverse portfolio of engineering operations with safety at their heart. These are widely seen as industry-leading niche businesses using a common operating model and all sharing the characteristics of being well-positioned in growing markets, technology-led, asset-light and with a high proportion of aftermarket revenues.

Products can be found in airport scanners, jet engines, apartment blocks and even NASA’s Mars Rover, and as decarbonisation presses ahead, it strongly positions Smiths to play a big role in re-equipping industry. It is also increasingly involved in energy transition, such as LNG (liquefied natural gas), green hydrogen and carbon capture.

Customers tend to be global enterprises, like Boeing (BA:NYSE), Airbus (AIR:EPA), Shell (SHEL) and ExxonMobil (XOM:NYSE), and national governments.

Having long resisted market pressure to break up the group, something that has attracted private equity to cast glances in the past, the appointment of CEO Paul Keel in 2021 saw Smiths embrace a shift for greater focus, concentrating on areas where scale could reap rewards. This process saw Smiths sell its medical division in 2021 for $2.4 billion, and it is still ongoing.

Analysts at Bank of America have flagged how this process has helped deleverage the balance sheet (net debt fell from £1.01 billion to £110 million in 2022) freeing resources for bolt-on acquisitions to add value elsewhere. ‘We see optionality to unlock significant value from broader portfolio transformation, such as we have seen elsewhere in the UK industrial space,’ said Bank of America, namechecking Spectris (SXS) and IMI (IMI), whose shares have rallied 28% and 27% respectively over the past year.

This will also help Smiths continue to improve important operating and investment metrics. For example, return on capital employed was 15.2% at the half-year stage, with a medium-term target of 15% to 17%.
Operating margins were 16.1% at the half-year stage and are expected to keep improving over the next few years.

While the implied forecast 2.5% dividend yield is nothing to write home about, estimated dividend cover in excess of two times this year implies scope to accelerate payout growth faster than earnings, if M&A opportunities prove hard to find. Bank of America calculates that Smiths’ stock is trading on a rough 25% discount to the sector on an enterprise value/EBITDA (earnings before interest, tax, depreciation and amortisation) of 11.5 times.

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