Shares digital

Meggitt (MGGT) – 292p, stop loss 234p

SHARES SUMMARY

Meggitt’s poor performance should change after transforming acquisitions in the US. Fast rising sales, profit margins and earnings with long-term visibility, the shares are at least 20% too cheap.

Business:

Design and manufacture of equipment and systems for aeroplanes and defence industries.

Vital stats:

Market value: £1.9 billion

Historic PE for 2007: 13.2

Prospective PE 2008: 10.8

Prospective PE 2009: 9.6

Sector PE: 13.4

1-month relative strength: -1.6%

1-year relative strength: -8.7%

Yield for 2007: 2.8%

NMS: 10,000

Spread: 0.1%

The Jeremiahs predict the aviation cycle has reached its peak and the boom is over. Not so judging by results from most of the aerospace component makers reporting in the last fortnight, including Senior (SNR) and Hampson Industries (HAMP).

Well respected Meggitt chief executive Terry Twigger reckons the cycle has another six years to run, if not longer, and the higher number of planes flying means bumper profits on spare parts.

Aftermarket revenues account for 44% of Meggitt’s sales and are rising rapidly. This week’s results showed organic sales growth of 11% and underlying profits growth of 13%. Order intake is up 35% – 2007 being the best year ever – with 2008 expected to come close.

Admittedly the rate of increased orderbooks – now over £650 million – will undoubtedly slow, but Airbus and Boeing have enough work to keep their factories working flat out until 2014. Best of all, most of this work comes from fast growing airlines in the Middle and Far East while the much larger American airlines have yet to replace their ageing fleets.

The key to Meggitt is the step change it achieved buying aerospace components business K&F Industries in America for just under £1 billion a year ago. Twigger came in for a bit of criticism for overpaying at the time but no longer.

K&F is doing better than expected and cost savings from merging its operations with Meggitt will amount to at least £22 million against the original figure of £16 million. The group is now a global leader in making fuel tanks and braking systems including Dunlop.

Wheels and brakes made by Meggitt are installed on over 30,000 aircraft with more than 800 planes fitted out last year. The continued growth of aircraft fleets and higher utilisation means more spare part sales.

A bonus is soaring energy costs has meant a big jump in orders for the compact heat exchanger business serving the oil and gas exploration sector, including a £7 million order for a sour gas processing plant in the Middle East.

Aerospace equipment sales account for 60% of turnover followed by sensing systems with 27% and defence systems with 13%. Sensing sales include engine monitoring systems for aerospace and energy customers and profits rose 10% on sales up 11%.

Higher US defence spending means this side also looks solid for years to come. Though profits rose just 3% last year, the orderbook surged 33%. Development contracts should result in production contracts worth over $500 million starting in 2014 such as the 30mm autoloader for the Infantry Carrier Vehicle for the US Army.

Meggitt was actually rated higher several years ago than today as higher profits sometimes failed to translate into higher earnings per share.

Analyst Clive Forestier-Walker of Numis points out that Meggitt is one of the best run companies in the sector with the highest profit margin at 24.6% and rising.

Walker expects organic growth to accelerate over the next few years driven by the high margin aftermarket. He expects to lift his profit forecasts by 4% this year to 26.6p cutting the PE to just under 11 falling to 9.6 in 2009.

This represents a 20% discount to its US peers and with two thirds of sales in the US market, Meggitt is a quasi-American company. If this discount persists it could face a takeover.

Target price 350p and could be nearer 400p once the re-rating takes place combined with more good earnings growth.

by: Timon Day