Spirax-Sarco (SPX:) How much should you pay for quality right now?

Spirax-Sarco (SPX) appeared on my SharePad Covid-19 ‘special’ bargain hunt:


" I will use Spirax-Sarco (14) as a brief example of the extra research we should all be undertaking right now.

Spirax is a FTSE 100 member that designs and manufactures what it describes as “ industrial and commercial steam systems ”, which apparently include “ condensate management controls and thermal energy management products ”…

Spirax states 85% of its revenue is generated from their customers’ annual maintenance and operational (opex) budgets. The group claims:

Capex budgets are more likely to be cut during periods of slower growth or recession. Therefore, the high proportion of revenue deriving from opex budgets gives us resilience during economic downturns.

What’s more, Spirax notes 50% of revenue is derived from “ defensive, less cyclical end markets ”, such as food and drink manufacturers, pharmaceutical groups and water utilities.

Significant levels of ongoing revenue alongside customers that are not at the forefront of the crisis seem a good combination to me at present.

The market seems to agree. The chart below shows Spirax’s trailing P/E remaining at an elevated 30x (green line, blue circle):"


SPX shares were then £78. Now they are £91. The other day they reached an all-time high of £96.

The AGM trading statement commendably gave an idea as to the impact of the pandemic:

“As a result of cost containment and efficiency improvement initiatives that have been put in place, we currently anticipate that the full year drop through of total revenue decline to operating profit in 2020 will be contained to around 45%.”

That reads to me operating profit could fall 45% this year. Bear in mind the "worst of the downturn" will occur in Q2 and Q3…

"While trading in the first four months of the year has held up well, we currently believe the worst of the downturn will occur in the second and third quarters of 2020. Absent a resurgence of the COVID-19 pandemic in the second half of the year, we currently expect trading conditions to improve in the last quarter of 2020, resulting in a lower contraction of organic sales in the second half of 2020 than in the first half. "

…suggesting Q2 and Q3 profit may fall more than 45%.

SPX’s 2019 results showed adjusted earnings of £2.66 per share. The trailing P/E is therefore 34x.

I know investors ought to ‘pay up’ for quality and SPX is a high margin, high ROE business with a good competitive position. I can also understand current shareholders holding on (it has paid to hold onto to ‘highly rated’ quality over time)…

…but why would anyone buy SPX now given the current rating and immediate outlook?

I look at City of London Investment (CLIG) for instance:

Sure, CLIG is a fund manager (with all the issues that brings) and not of the same ‘business quality’ of SPX. But CLIG’s yield is 9% and by my calculations – assuming the market does not undergo a severe, protracted downturn – the dividend is sustainable.

I wonder which investment will do better over the next 5 years. SPX or CLIG? My money is on CLIG (I own the shares!) at 315p versus SPX at £91.

Some quick maths:

For CLIG to return roughly 15% a year during 5 years, the 9% dividend has to be sustained and EPS grow 9% annually from its current lows (assuming the share price follows EPS higher – i.e. the P/E is maintained at c11x).

For SPX to return roughly 15% a year during 5 years, the 1% dividend has to be sustained and EPS grow 14% annually from their £2.66 per share level of 2019 – which could be difficult given profit is already set to drop 45% for 2020.

Any thoughts?