RBC backs UK engineering, dismisses downturn concerns

Fears that the British engineering sector is facing a significant downturn have been overplayed, according to analysts at RBC Capital Markets, leaving a number of companies undervalued.

There are growing concerns that a global slowdown in economic growth will hurt engineering companies particularly badly, and many investors have sold out of the sector.

But the Canadian bank downplayed expectations of a recession in a note on Tuesday. “Lead indicators have rolled over and weakness is clear in certain markets, for example, automotive," it argued. "However, it is less clear that is a widespread downturn."

It continued: “Given our view that in many cases a significant recession scenario is being priced in, we have a bias towards outperform ratings in our coverage group.

“We have an average upside to our price targets of 22% and all but Rotork from our ‘buy’ ratings has upside in excess of this level. In the case of Rotork we see its net cash position and strong long-term delivery track record as an added support.”

RBC has a price target of 345p for Rotork upgraded the shares to an ‘outperform’ rating. However, its top picks are Melrose Industries, with a price target of 235p, and Vesuvius.

“Melrose management has a unique ‘buy, improve, sell’ model,” it argued. “While GKN is the largest transaction they have undertaken, a forecast margin improvement of around 400bps is conservative versus a history of 600bps+ uplifts on past deal.” The FTSE 100 turnaround specialist acquired GKN through a £8bn hostile takeover earlier this year.

Vesuvius has a price target of 700p. “We see a 12.5% operating margin target in 2020 as achievable. Our 2020 earnings per share [estimate] is around 9% above consensus as we forecast the 12.5% operating margin being achieved as a second half run rate.”

Bodycote was also initiated at 'outperform' and IMI was started at 'sector perform', with analysts also starting RHI Magnesita at 'outperform', the same level to which they downgraded Smiths Group and Spirax Sarco.