Shares in this manufacturer of pumps for transporting basic minerals, oil and sea water have jumped recently, so why are we advising it’s time to take profits?
Weir Group (WEIR), tipped as a BUY by by Numis Securities
Last week, shares in Weir, a manufacturer of specialist pumps for transporting basic minerals, oil and sea water, jumped more than 10% as it bought SPM Flow Control for $653m. SPM makes high-pressure pumps and related equipment for use in the oil and gas industry; sales are expected to hit $320m this year. Its pumps help stimulate extra oil and gas output from mature fields, extending the wells’ economic lives. As the pumps are used in very harsh conditions, 45% of revenues come from selling high-margin replacement parts. North America provides 88% of its turnover but it sees cross-selling opportunities globally. And non-conventional wells, which need expert attention to be viable, comprise one of the fastest-growing segments of the oil-services market.
Unsurprisingly, CEO Mark Selway was bullish on the deal: “SPM has a great market position in a core sector for Weir and we have good potential to improve the business through our operational expertise, geographic profile and financial strength.” The City also responded warmly, lifting earnings forecasts.
Given all the euphoria, why do I feel it’s time to take profits? There is a good strategic fit between the two firms, but the underlying value of the stock is more important. And after an 85% rise from 400p only 12 months ago to 740p now, I think the shares are expensive. First, there’s a real danger that Weir may have bought SPM at the top of the cycle. SPM has seen a fivefold rise in turnover in the last three years, with operating margins up from 12% in 2004 to an estimated 26% for 2007. This looks too frothy for a mature industry – even allowing for high crude oil and commodity prices. Next, Weir’s stock is valued on a 2007 p/e ratio of 20, which looks vulnerable for a manufacturer and servicer of pumps. Finally, after the deal, Weir will generate around 75% of sales (and probably over 85% of profits) from the oil and gas, mining and power sectors. Whether such customers can pay top dollar for its products depends on future commodity, energy and oil prices, which are notoriously volatile. Many mining and oil firms are valued on p/e ratios of only ten to 14 – and hence offer much better value than Weir.
So I think there is more downside than upside risk for shareholders. In fact the CEO and another director sold £0.55m worth of shares only last week at 722p, following the SPM announcement.
Recommendation: TAKE PROFITS at 753p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments