Self-Improvement Hasn't Come Fast Enough For Rotork

When I last wrote about Rotork (OTCPK:RTOXY) (ROR.L), I said that this British manufacturer of valve actuators and controls needed to accelerate product development and margin improvement efforts to support its valuation. Since then, the key oil & gas market has weakened dramatically and the shares have modestly underperformed the industrial sector. Weak organic growth remains a key concern, as although the company has made some progress on the product development front, it just hasn’t been significant enough to shift the company’s revenue mix all that much.

Rotork has good technology, and I expect electrical valve actuation technology is only going to become more valuable as 5G drives industrial IoT adoption and growth. On the other hand, I believe capex spending in the oil & gas vertical could be pressured for possibly five years, and that’s going to seriously challenge management’s capabilities. More positively, I do see Rotork as an increasingly attractive M&A target, though I’m not sure how much of a premium investors could reasonably expect to get.

 

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Self-Improvement Hasn't Come Fast Enough For Rotork

Rotork Needs To Add A Self-Improvement Kicker To Its Cyclical Recovery Story

Although I thought Rotork (OTCPK:RTOXY) (ROR.L) had more upside on the cyclical recovery theme back in late May, the 25% move in the shares since then was frankly more than I expected, as Rotork and peers like Emerson (EMR), Weir (OTCPK:WEGRY), and SPX Flow (FLOW) have seen strong moves on the emerging recoveries in process industries like oil and gas. While Rotork's revenue hasn't come back yet (on an organic basis), order growth has been strengthening and 2018 should be a much better year.

The cyclical recovery is only part of the story at Rotork, though. Margins have been weakening for a while, and it appears that the company is finally ready to do something about that. While a margin-boosting self-help program on top of a cyclical recovery could certainly boost cash flows, a lot is already baked into the share price.

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Rotork Needs To Add A Self-Improvement Kicker To Its Cyclical Recovery Story

IMI Group Working On Self-Improvement Through Still-Challenging Markets

Seemingly every company is looking to streamline its supply chain, improve manufacturing efficiency, and reduce its operating overhead, but the self-improvements at IMI Plc (OTCPK:IMIAY) (IMI.L) are a little more urgent. While declines in the oil/gas, power, petrochemical, industrial automation, and commercial vehicle markets have certainly hurt, IMI also saw some self-inflicted damage from under-investment in capex and R&D, too many non-strategic assets/businesses, and a lack of integration and operational efficiency. Credit, then, to CEO Mark Selway who has been tackling these issues in recent years while also dealing with serious market headwinds.

The opportunities for self-improvement and market recoveries haven't gone unnoticed, as IMI's shares are up about 25% over the past year - less than the likes of Weir Group (OTCPK:WEGRY) and Parker-Hannifin (NYSE:PH), but on par with Rotork (OTCPK:RTOXY) and SMC (OTCPK:SMCAY). My expectations for recoveries in downstream oil/gas and power may be too conservative, but I'm looking for mid-single-digit growth in revenue and FCF from IMI. That supports a mid-to-high single-digit return at today's level, which is not bad on a relative basis but arguably not enough for a company that still has some work to do on the self-improvement front.

Readers should note that IMI's ADRs are not very attractive from a liquidity standpoint, but the London-listed shares offer ample liquidity and most quality brokerages now offer such market access.

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IMI Group Working On Self-Improvement Through Still-Challenging Markets

Rotork's High-Quality Business Now At A (Somewhat) Lower Orbit

There are a lot of strong arguments to be made for focusing on high-quality industrial companies like Atlas Copco (OTCPK:ATLKY), 3M (NYSE:MMM), Rockwell (NYSE:ROK), and Rotork (OTCPK:RTOXY), but valuation is often a challenge. I had issues with Rotork's valuation in the past, and its heavy skew to the oil/gas markets has more than outweighed its overall strength in valve actuators and related products in recent years, sending the shares down about 30% since my last update on the company. Even now, the shares are not what I would call conventionally cheap, though the possibility of regaining a premium valuation as its end-markets recover and it expands its business should not be ruled out or ignored by investors willing to embrace a wider perspective on valuation.

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Rotork's High-Quality Business Now At A (Somewhat) Lower Orbit

Seeking Alpha: Rotork Has All The Quality You Could Want

I'm not sure how a reader could fault Rotork (OTC:RTOXY) on the basis of quality. This British industrial company has established leading market share in valve actuators (devices fitted to valves to control them, and the flow of fluid and gas), and actually grew through the 2009 downturn when most industrial companies were seeing significant pressure in their business. Rotork has not just grown, it has grown profitably, with a five-year average return on invested capital over 30%.

Quality isn't the issue with Rotork, but valuation might be. I readily admit that high-quality companies often get and hold a premium multiple. Rotork is also looking to redefine its business once again and expand its addressable market by about a third in the process. I'm not recommending betting against Rotork, but the market already seems to be counting on 10% annual free cash flow growth for the next decade and there are cheaper industrials out there right now.

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Rotork Has All The Quality You Could Want