Gamble of the week: a promising engineering firm

Over the past 25 years, Britain’s factory base has been gradually eroded, due to a relentless attack from cheaper imports. Unfortunately, many businesses have gone to the wall. Yet there are a few notable success stories, such as Manchester-based Renold.

The organisation is the world’s number-two player (12% market share) in industrial chains (66% of sales) behind leaderTsubaki of Japan (on 24%), but ahead of Rexnord (on 7%). The firm also supplies niche transmission products, including gears (14% of sales) and couplings (another 20%) that are used across a diverse range of applications.

These include everything from trains and ships to cement factories and steel mills. Europe and the Americas account for 78% of revenues, with the rest derived from Asia. That means that Renold is less exposed than some businesses are to the ailing British economy and is a net beneficiary of sterling’s weakness.

Renold (LSE: RNO)

Yet even so, Renold was hit badly during the recession. In particular, it suffered massive destocking in its major territories – with sales set to drop 23% to £150m for the period ending March 2010. However, costs also have been slashed, saving £16m this year. Meanwhile, on 1 February, chief executive Bob Davies was cautiously optimistic. He said that “trading was in line with expectations”, and confirmed that “customer destocking had largely ended in Europe and will end in the first quarter in the US”.

As for the numbers, Singer Capital, the house broker, estimates turnover and adjusted earnings per share for the year ending March 2011 at £165m and 1.4p, rising to £174m and 3.4p in 2012. That puts the shares on an undemanding 2012 p/e ratio of 6.7. On this basis, Singer rates the stock a buy with a target price of 32p per share – more than 30% above the current price. Moreover, following a £26.9m share placing at 20p in November, the group has greatly strengthened its balance sheet (proforma net debt is just £19m), allowing management to invest in further operational improvements.

Of course, no share is risk-free. For starters, another slump would undoubtedly hit results again. Investors also need to watch the £73.8m pension deficit, along with the company’s foreign-exchange exposures. That said, with its strong customer relationships, Renold is a classic recovery play. It offers good upside and plenty of overseas protection from the stagnant British economy.

Recommendation: SPECULATIVE BUY at 23p

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

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