Investors’ Chronicle: Renishaw, Fevertree, Petra Diamonds

BUY: Renishaw (RSW)

Renishaw should be able to capitalise on the automation rush at a time when workers are hard to find, writes Alex Hamer.

For precision engineering firm Renishaw, the ramp up in spending on high-tech manufacturing capacity resulted in its highest sales ever and stronger profits, even with significant increases in production costs in the year to June 30.

Growth is in the pipeline through a headcount increase this year and a £64mn project to add capacity to the Wales production facilities over the next three years. This is the dominant part of the capital expenditure plan, with £88mn committed as of June 30 company wide.

There are worries going forward, however, as this year may mark a high point for industrial demand if the recession starts to bite.

Executive chair Sir David McMurtry said the rougher conditions were already having an impact, even if the order book was in good shape. “We have, however, recently seen a weakening in order intake from the semiconductor and electronics sectors, and general market sentiment is becoming more cautious,” he said.

The total cost of sales climbed 16 per cent in the year to £313.5mn. On an adjusted basis, profit outstripped this, pushing the adjusted profit margin up from 21 per cent to 24 per cent. The key adjustment was a one-off charge of £11.7mn from added pension scheme liabilities.

Analysts are bullish about Renishaw continuing to grow: consensus estimates are for further sales growth in the 2023 financial year and continued improvement in profits, peaking in the near-term at £179mn in 2024.

SELL: Fevertree (FEVR)

The company reiterated its latest full-year guidance, but the outlook remains volatile, writes Christopher Akers.

Fevertree’s July update flagged the cost pressures that are weighing down the company’s margins, so the confirmation of their impact on the half-year results came as no surprise. More detail was forthcoming on how management intends to attempt to mitigate the cost burden, but whether this can fundamentally improve the situation given an asset-light business model remains to be seen.

Outsourced production and logistics means the company is exposed to struggling supply chains and rising costs. As expected, there was a significant hit on profitability in the half from higher glass bottle costs, glass availability, labour shortages, and sea freight costs. Gross margin fell by 670 basis points to 37 per cent and the adjusted cash profit margin was down by 700 basis points to 14 per cent.

The company said it is looking at several measures to address this. This includes improving local production capacity, with plans for US canning and Australian bottling facilities next year, and enhancing procurement. Such steps are positive and important ones to take. But the longer-term margin outlook remains challenging, and in the short-term the impact of inflationary pressures is expected to be worse in the second half.

When it came to the top line, there was nothing much new to report given the summer’s update provided a sales breakdown for the half. On-trade recovery boosted sales, with US and Europe trading ahead of pre-pandemic. The strongest growth came in Europe, where revenue was up 31 per cent to £52mn. UK revenue was up 6 per cent to £54mn, US revenue by 9 per cent to £40mn, and rest of world revenue by 5 per cent to £15mn.

Fevertree faces problems in the US market, despite revenue growth across the Atlantic. Analysts are unconvinced that the company can materially bump up its margins there — broker Peel Hunt thinks these currently sit in the low single-digit range. Premium mixer business Powell & Mahoney, acquired in August for $5.9mn (£5mn), could help, but it is hard to see how the company gets out of the low-margin hole.

Numis analysts said that “the cost outlook remains challenging but the company has also made good progress in terms of enhancing its supply chain capabilities”. The shares trade at 40 times the house broker’s 2023 financial year earnings forecast, a rating we think is just too expensive to justify. And poor cash generation and conversion, with only £1.5mn cash generated from operations in the half, is another sticking point.

HOLD: Petra Diamonds (PDL)

The diamond miner announces new dividend policy and will pay off $150mn in loan notes early with higher cash flow, writes Alex Hamer.

A few products of Petra Diamonds’ Cullinan mine in South Africa will soon be back in front of a global audience: two stones cut from the immense Cullinan diamond found in 1905 are part of the Crown Jewels, including the centre stone of the sceptre used at coronations.

The current owner of the mine is still digging up big rocks: Petra reported a strong tender result of $103mn (£89.32mn) alongside its 2022 financial year numbers, a fifth higher than the previous sale, which it put down to “a high proportion of high-value gem-quality single stones” from Cullinan.

The company reported stronger profit numbers overall, for the year ending June 30, due to higher diamond prices and higher production because of the restarted Williamson mine in Tanzania. Petra is now almost two years on from a deal with lenders that handed most of the company over to them. Now it wants to hand those still on the shareholder register some income to go with their holding — while not bringing it in immediately, the miner said it would aim to pay out 15-35 per cent of operating free cash flow. That would equate to $35mn to $81mn using the 2022 figure of $230mn. 

The balance sheet and portfolio remedial work is not yet finished — Petra is dropping its stake in the Williamson mine, which has long been a difficult asset. The company has paid millions to locals over human rights abuses and the Tanzanian government has proved to be a difficult partner. It will hold on to operational control however, even after its mining contractor takes a bigger stake.

We said last year that Petra’s reorganisation would not get rid of the operational risks it has seen in the past at its mines. This is still the case even with a stronger diamond market.

Hermione Taylor: How will gilt markets react to Trussonomics?

By the time results rolled in on September 5, Liz Truss’s victory had been largely priced in by financial markets. But the new UK prime minister faced a less than warm welcome: two-year gilt yields hit 3.18 per cent, up from 2 per cent a month before. At the longer end of the curve, the 10-year yield leapt to almost 3 per cent. Why the cool reception?

Truss has an unenviable economic inheritance. Soaring energy prices have pushed inflation to double digits, intensifying pressure on the Bank of England to increase interest rates to cool the price level. The BoE is set to begin a programme of active quantitative tightening this year, meaning gilt markets will need to absorb an additional £80bn of assets. Public finances are also under huge pressure: pensions, certain benefits and around a quarter of government borrowing costs are inflation-linked — a problem when RPI is running at 12.3 per cent.

But the prime minister also looks set to add a new set of stressors to the mix. Truss has announced a broad £150bn package of energy bill support for companies and households, and confirmed in her victory speech that she intends to deliver a “bold plan to cut taxes”.

Despite a number of fiscal rules, there is no specific threshold at which public finances become unsustainable. But if the UK’s borrowing patterns differ significantly to other economies, the government may find it more difficult to sell its debt. This market reticence could coincide with investors being asked to increase their exposure to gilts by a record amount: £120bn this year and £210bn in 2023, according to ING estimates. Will markets take a dim view of the government borrowing to cut taxes and increase spending in an environment of rising rates?

It is worth noting that not all borrowing is created equal. Panmure Gordon’s chief economist Simon French argues that markets take into account the “environmental factors” of borrowing: will it improve productivity? Does the government have a healthy respect for the rule of law? And, crucially, will it help the economy to grow?

Paul Dales, chief UK economist at Capital Economics, argued in a September 5 briefing that energy price increases are a crisis worthy of dramatic measures. If government support allows viable businesses to continue and helps households to stay in the workforce, the UK economy may emerge from the crisis with stronger growth than if the government left households and businesses to absorb higher energy costs. But he cautions that the UK government must signal its intention to maintain fiscal discipline in the long term: if Truss’s team can’t convince investors, markets will demand higher interest rates to lend to the UK government.

This disquiet is manifesting itself in the gilt market. Yields on 10-year and two-year gilts climbed in the month before Truss’s victory. What’s more, the yield curve inverted, with yields on a two-year gilt higher than a 10. This is unusual. In normal times, investors need to be compensated for holding longer-term debt. Yield curve inversions spark concern in financial markets and are often seen as a harbinger of recession.

This recession warning worries equity investors, too. The FTSE All-Share dipped briefly into a bear market in 1989-90 and wobbled in 1998 due to the Asian and Russian debt crises. It plunged in 2000-2003 as the tech bubble burst, and collapsed in 2007-09 as the Financial Crisis struck. On each occasion, as AJ Bell research notes, the yield curve inverted.

As an indicator, the inverted yield curve isn’t perfect — it did briefly give a false signal in August 2019. But could it be a sign that stock market turmoil lies ahead? Not necessarily: it is possible that markets will be soothed as we learn more about the mechanics of Trussonomics and how the huge energy support package will be funded. The devil, after all, is in the detail.

Hermione Taylor is an economics writer for Investors’ Chronicle