Richard Beddard: numbers only tell half the story at this top-ranked stock

Our ‘Decision Engine’ columnist tackles this top-scoring industrial business engaged in a turnaround.

Judging by the numbers, Goodwin (LSE:GDWN) is currently not a particularly remarkable business or necessarily undervalued. However, I believe the numbers only tell part of the story.

The company’s attraction as an investment lies in the actions of management, which is turning around unprofitable businesses and keeping the profitable ones healthy.

A tale of two turnarounds

The problems lie in the Mechanical Engineering half of the business, which is the only UK company that can cast high performance alloy in sizes of up to 35 tonnes. I believe it is one of only a handful of companies worldwide that can do this.

Much of the output of its foundry, Goodwin Steel Castings, is destined for its machine shop, Goodwin International, which is suffering losses due to the declining oil and gas industry.

The company is seeking to replace falling revenues from products like check valves, which control the flow of oil in pipelines. Reduced investment by oil companies since the oil price crash of 2015 has been exacerbated by a scramble by the same companies to invest in green energy.

Goodwin has pivoted into the military and nuclear sectors by winning orders for components for nuclear propulsion systems and nuclear waste containment boxes.

The first nuclear waste containment boxes have been delivered by Goodwin Steel Castings to Goodwin International for machining and assembly when they will begin the fulfillment of the largest order in the company’s history.

Winning these orders has taken years, and the company expects its naval and nuclear programmes to span decades.

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Another Goodwin business involved in a protracted turnaround is EASAT. Formerly a supplier of mechanical components (antennae) for air traffic control systems, the company has spent the last five years developing full-blown systems using the software and sensor capabilities it acquired with NRPL in 2016.

Vertical integration is a strategy favoured by most of the company’s many subsidiaries and the sale of a system is worth ten times the components Goodwin would have supplied for it, the company says.

Although the pandemic has reduced demand for air traffic control equipment, Goodwin expects to make more sales in the Far East following the commissioning of two systems in 2021.

Improvement in the numbers

The question is, can Goodwin return these businesses to decent levels of profitability and the group to high levels of profitability, without suffering sustained reversals in its many other businesses.

Before 2015 it was not uncommon for Goodwin to achieve a 20% return on capital. Since then it has managed about 10%, which is viable, but by no means remarkable.

The numbers this year offer some reassurance.

The fact that Goodwin has not grown revenue or profit since its heyday in the middle of the last decade is perhaps less remarkable than the fact that it has not contracted as it has reorientated the Mechanical Engineering business away from oil and gas.

In the year to April 2021, Goodwin earned 32% more profit despite a 9% decline in revenue. It lifted return on capital from 9% to 11%.

The company explains in its annual report that new naval and nuclear contracts are beginning to pay off. A surge in profit from the Mechanical Engineering division was “a result of the higher margin contracts for nuclear decommissioning and naval vessel building programmes starting to ramp up as compared to the margins available in the declining oil industry”.

Weak cash conversion over the last eight years is explained by the investment required to re-equip Goodwin’s foundry in Stoke, enabling it to cast in larger sizes, and many other investments.

Goodwin was quick to recognise the challenges it faced at Goodwin International and EASAT, and the strategies it has employed probably address them.

But through no fault of Goodwin, things are moving slowly because of the time it takes to accredit new and highly technical products, which has been exacerbated by delays due to the pandemic .

Meanwhile, Goodwin has its fingers in lots of other healthy pies.

Also in the Mechanical Engineering division Goodwin says it is generating more income from servicing its well established fleet of submersible slurry pumps in operation in mines around the world.

Submersible pumps contributed 14% to profit in 2021, and thanks to high mineral prices, Goodwin expects substantial investment from its customers.

Source: Goodwin

The other half of the business, Refractory Engineering, made a record profit in 2021. It has been growing in recent years as the company has made acquisitions, vertically integrated operations, and innovated.

Refractory Engineering supplies minerals, primarily used in the casting of jewellery and tyres, but also in many other niche applications. Goodwin says sales of fire extinguishers made by a subsidiary, Dupré, are gaining momentum. They contain a mineral, vermiculite, processed by Dupré and also used in insulation and friction brake linings.

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It is one of many examples of Goodwin’s industry and entrepreneurialism. Another that may pay off further in the future is the company’s investment in a production process for high temperature polymers. It would open up yet another materials market to Goodwin.

Scoring Goodwin

Any business refocusing on new markets is taking risks, however Goodwin has a long pedigree, having reorientated the business to supply the military during two world wars and as the age of steam gave way to the age of oil.

It is currently run by the sixth generation of the Goodwin family and with the workforce it has nurtured over the decades it has great engineering and entrepreneurial expertise.

While owning so many subsidiaries makes Goodwin a complicated business, its large board should help manage that complexity.

Does the business make good money? [1]

?  Recent returns on capital undistinguished

?  Weak average cash flow

+ Potential for improvement in both

What could stop it growing profitably? [2]

+ Nuclear and military contracts less cyclical

+ Strong finances

? Complex business

How does its strategy address the risks? [2]

+ Diverse industrial and geographical markets

+ Vertical integration of both divisions

+ Focus on markets where competition is limited

Will we all benefit? [2]

+ Goodwin family owns more than 50% of the shares

+ Experienced management and workforce

? Need to keep an eye on incentives

Is the share price low relative to profit? [1]

+ A share price of £31.50 values the enterprise at about £269 million, about 18 times adjusted profit.

A total score of 8 out of 9 suggests Goodwin shares are a good long-term investment.

If Goodwin’s new business lifts profitability, shareholders should be rewarded more handsomely than they have been in the recent past.

I think Goodwin is one of those “heads I win, tales I do not lose” stocks, with the coin weighted towards “heads I win”.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.

Richard owns shares in Goodwin

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Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard