The stock market has had to cope with a raft of conflicting economic data over the past few days.
News that inflation was at its lowest level in five years last month concerned analysts earlier this week. Even though high inflation is seen as something to be avoided at all costs, extremely low inflation figures suggest the economy remains fragile.
Indeed, the official data organisation, the Office for National Statistics says the outlook is unsettling – consumers, companies and the Government are still bogged down with debt, unemployment is rising and banks remain reluctant to lend money. Against that, the rate at which unemployment is rising is slowing down and some big mining companies, such as Rio Tinto, say there are signs of recovery. This helped the FTSE 100 on Wednesday and share prices rose.
Positive comments from the miners play to the strengths of Scottish-based engineer Weir Group. At the beginning of this decade, the company was a rather old-fashioned engineering conglomerate – it had numerous divisions, serving numerous sectors and a number of its businesses were low-margin, so the amount of profit they generated was relatively small.
Chief executive Mark Selway changed all that. Appointed in 2001, Selway turned Weir into a highly-focused company, specialising in three areas, minerals, oil and gas and power. In the first two divisions, Weir provides sophisticated equipment, such as innovative pumps and valves to help companies extract minerals, oil and gas from land and sea.
Weir also supplies complex but vital kit to power companies, ranging from conventional electricity generators to nuclear and renewable energy groups.
Weir
Weir does not just make the kit however. It also has a robust after-care, service and maintenance business. This is particularly important in industries which work their equipment hard, such as mining companies, and areas where safety is critical, such as nuclear power stations.
Weir’s after-care division has proved extremely helpful during the economic downturn, cushioning the group from the worst effects of recession. In the six months to 26 June, for example, orders for original equipment fell 36 per cent to £273 million but spare part orders were down just 2 per cent to £248 million, while demand for servicing rose 5 per cent to £136 million.
Weir is far from complacent about the future but the company should be one of the early beneficiaries of economic recovery. Mining companies are already seeing demand for metal pick up, particularly in China and other emerging markets. Oil and gas and power should follow. Initially, Weir’s customers may not want to buy large amounts of new equipment but, as they use existing kit more, the need for spares and service will increase.
The company will issue a trading update in mid-November and some brokers believe this will be more positive than expected. In 2008, Weir made pre-tax profits of £176 million. Most analysts expect a slight fall to £170 million this year, reflecting the economic slowdown, particularly in North America. Until recently however, followers of the company expected a much larger decline in 2009 profits. And next year, the company may well recover more quickly than anticipated, as Asian economies grow stronger and use more metals and other commodities.
In September, Weir announced that Selway would be leaving at the end of the year. A native Australian, he has been offered a job Down Under and decided to go home. The impact of this has been deflected, fortunately, as finance director Keith Cochrane is stepping up to the plate. Cochrane has been with Weir since 2006 and has been instrumental in transforming the company from what it was to what it is today.
Midas verdict: Weir shares are trading at 750p. They have done well in recent weeks but are still well below the high of 970p reached in the summer of 2008. The stock should rally as economic conditions improve and brokers become more appreciative of the company’s spread of businesses. Buy.
IQE
Almost a year ago today, Midas Extra recommended shares in IQE, a Welsh-based technology firm.
The company is small and specialised but it is a world leader in a product called gallium arsenide, a crucial ingredient in the software chips for a wide range of products, including the increasingly popular iPhone.
Most people have heard of silicon chips but gallium arsenide chips are much more powerful, much more efficient and much more flexible. In fact, the first iPhone had just one such chip, later models used four of them and now some mobiles have up to 18 of them, as phone manufacturers turn mobiles from something used to make and receive calls into mini-computers. Gallium arsenide is also used in laptops, satellite navigation systems in cars, TV satellites, CDs and DVDs.
It is used too in so-called LED lighting, which is highly energy efficient and expected to replace ordinary light bulbs entirely over the next ten to 20 years.
Last week, IQE expanded its presence in the LED field through the acquisition of NanoGaN, a technology group spun out of the University of Bath. NanoGaN has pioneered a way of making next-generation lights that are more powerful, more efficient and longer lasting than anything currently on the market.
The lights, known as LED and blue-lasers, will be used for electronic devices, such as phones and computers, but also for homes and businesses. The technology behind these lights was invented by Professor Wang Nang Wang, chief executive of NanoGaN and he is joining IQE as chief scientific advisor.
The acquisition does have an element of risk but IQE chief executive Dr Drew Nelson, has minimised the downside by paying just £400,000 up-front with the remaining £3.2 million to be delivered as and when NanoGaN meets certain targets.
IQE is expected to deliver profits of £2.2 million this year, compared to a loss of £1.4 million in 2008. In 2010, profits of more than £3 million are expected, rising to £5 million the following year.
Midas verdict: IQE shares were 12.8p last October. They fell as low as 6p at the beginning of 2009, not because the business was doing badly but because the market was worried about small technology stocks. Now they are 16p, a rise of 25 per cent. There is plenty of further upside in this business, especially after the recent acquisition. Hold.
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