A strong case for buying three cheap UK industrial stocks

This trio has a record of delivering more resilient earnings in periods of broad-based economic slowdown, but are trading on depressed valuations.

Overlooked industrials IMI (LSE:IMI), Spectris (LSE:SXS) and Spirax-Sarco Engineering (LSE:SPX) were today described as “compelling” opportunities after their valuations became caught up in UK economic turmoil.

Bank of America said the sector’s current 25% discount to European peers and 10% globally made no sense when only an average of 6% of 2021 revenues were generated in the UK.

It argues that economic issues are background noise for earnings and that UK companies are fundamentally better positioned against European counterparts in a number of key areas.

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The City bank points out the majority of its “buy” recommendations are trading with one-year forward earnings valuations considerably below both their five and 10-year averages.

For valves and flow control equipment firm IMI and the precision measurement business Spectris, the bank thinks this completely overlooks the fundamental changes that have recently taken place in terms of addressing their cost bases.

It also highlights the appeal of steam management and pumps business Spirax after a 30% de-rating so far this year.

The Spirax sell-off comes despite its highly defensive qualities through revenues in pharmaceuticals and food and beverage and its exposure to favourable investment themes such as energy efficiency and industrial heat generation.

The bank has “buy” recommendations on all three stocks, as well as the flow control and instrumentation business Rotork (LSE:ROR), metal flow engineer Vesuvius (LSE:VSVS) and the smaller Pod Point Group Holdings (LSE:PODP), which is focused on electric vehicle charging solutions.

Why so cheap?

Bank of America thinks that recent political and economic turbulence in the UK is to blame for the current depressed valuations.

Investor feedback also suggests the perception of UK industrials is that they are often too complex for their size, with many companies more like mini-conglomerates.

The most UK exposed of the larger stocks in Bank of America’s industrials coverage is Halma (LSE:HLMA), with around 18% of revenues. But the company operates in niche areas and benefits from exposure to defensive and thematic growth, such as fire safety and environmental analysis, that should insulate it against issues in the wider UK economy.

Most companies generate a large portion of their revenues outside of Europe, which Bank of America thinks should appeal given the ongoing energy price shock and Ukraine war.

UK industrials also have much less exposure than their European peers to construction markets, where volumes have deteriorated in the third quarter and an expected destocking could exacerbate this further in the current quarter.

Bank of America adds that UK industrials have a record of delivering more resilient earnings in periods of broad-based economic slowdown. It said: “The relative de-rating therefore offers, in our view, particularly compelling opportunities in our key Buys.”

Out of favour

The bank has “underperform” recommendations on Bodycote (LSE:BOY), Morgan Advanced Materials (LSE:MGAM), Smiths Group (LSE:SMIN) and Weir Group (LSE:WEIR), alongside “neutral” positions on Halma and Melrose Industries (LSE:MRO).

This reflects its cautious stance on companies with relatively high exposure to automotive production in Bodycote and Melrose, and cyclical earnings risk in Morgan Advanced Materials..

It adds: “We are notably more optimistic and ahead of consensus on stocks with clear thematic tailwinds, e.g., Spirax on energy efficiency demand and IMI on increasing automation spend/reshoring trends.”