This engineer's share price has soared 33pc despite tariff troubles
An upgrade to future profit guidance typically galvanises investor sentiment. Indeed, firms that raise their projections for bottom line growth often experience a sharp increase in their share price as investors hurriedly factor in a more bullish outlook.
This has proven to be the case with engineering company Smiths Group. Shares in the FTSE 100 member have soared 33pc higher since the start of the year. In doing so, they have outperformed the wider index by 25 percentage points.
This performance follows two upgrades to the firm's profit guidance during the current financial year, as well as a recent trading statement which flagged that this year's organic revenue growth (which excludes the impact of acquisitions) will now be towards the top end of a 6pc-8pc forecast.
The company's third-quarter trading update also showed that it is experiencing growth across each of its various divisions. Combined, this meant that organic revenue growth stood at 10.6pc for the quarter and at 9.6pc for the first three quarters of the current financial year.
The firm's operating profit margin, meanwhile, is still set to grow by 40-60 basis points in the 2025 financial year. This follows a 34 basis point increase last year and a 50 basis point rise in the first half of the current year. When considered alongside last year's return on an equity figure of around 16pc, this highlights continued improvement in the firm's competitive position.
Rising profit margins alongside brisk revenue growth mean that the company's bottom line is set to increase at an annualised rate of 11pc over the next two financial years. While this figure could naturally be affected by potential changes to tariff rates, Smiths Group is relatively well placed to overcome a global trade war.
Although 45pc of its revenue is generated in the US, a significant majority of its sales to the world's largest economy are domestically produced. This means that, while a global economic slowdown caused by greater protectionism could impact its financial performance, it may be better able to overcome the imposition of higher tariffs than many other firms.
Furthermore, the company's sound balance sheet means it is well placed to capitalise on any future economic downturn via M&A activity. It has a net gearing ratio of just 12pc, while net interest costs were covered over 20 times by operating profits in the first half of the year.
This has allowed the firm to make several acquisitions over recent years, and it expects to make further purchases over the medium term. Sound finances also mean the company is able to engage in a share buyback programme totalling £500m. It has currently purchased £260m of shares and expects to complete the remainder by the end of the calendar year, which should provide support to its share price in the short run.
Investor sentiment may also be buoyed by the implementation of a revised strategy announced earlier this year. The company plans to divest several parts of its business over the coming months in order to focus on faster growing segments that offer greater scope for rising profitability.
Since Questor tipped Smiths Group as a 'buy' during May 2017, it has produced a 46pc capital return, which compares favourably with a 16pc gain for the FTSE 100 index. Since being added to our income portfolio in November last year, it has gained 34pc.
A surging share price unsurprisingly means the company's dividend yield has fallen from an already below average 2.5pc eight months ago to just 1.9pc today. However, the company's dividend cover of 2.4 and growth in shareholder payouts last year of 5.2pc, which was more than twice the rate of inflation, still hold significant appeal – and with double-digit profit growth ahead, which could prompt further inflation-beating dividend increases, the stock's income appeal remains relatively high.
Trading on a price-to-earnings ratio of 21.9, Smiths Group still offers scope for an upward rerating. Its strong competitive position and excellent balance sheet highlight that it remains a high-quality company that investors are likely to become increasingly bullish towards as it delivers a faster pace of profit growth.
With the potential for further acquisitions, as well as the positive influence of a share buyback programme, Questor remains upbeat about the company's share price prospects and its capacity to deliver further index outperformance. Therefore, it represents a worthwhile long-term purchase that has not yet delivered on its potential.
Questor says: buy
Ticker: SMIN
Share price at close: 23.06
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