Fenner’s (FENR.LON) share price has gained 200% from its 2016 trough level. But it’s worth remembering that the trough-to-peak share price move from 2009-2012 was 1,280%. The company makes polymer conveyor belts for mining and heavy industries as well as specialised polymer components for a range of applications from specialised industrial to oil and gas to medical devices. Some of these markets have been depressed in recent years, particularly the mining and energy resources segments. However, we believe that a recovery is now beginning which, like the company’s conveyor belts, will keep going and going.
STRATEGY
Drivers for 2017-2020
In the oil & gas segment, Fenner (FENR.LON) is significantly exposed to US hydrofracking. This was the main driver for an almost 60% decline in Fenner’s (FENR.LON) O&G revenues from 2014-2016 . However, there are signs of a healthy recovery under way in this segment, and we expect a positive incremental profit contribution starting from 2017. More details of this on page 2.
Coal markets have also been a headwind in recent years. In Australia, where Fenner is clear market leader, revenues and profitability were held back by destocking, a lack of new projects and pricing pressures. US coal revenues for the conveyor belt business declined to a near stand-still during 2015. We expect a steady recovery from 2017 onwards, although coal is now the smaller part of the US business with the industrial business (serving the construction materials and other non-coal markets) seen as having better long-term growth prospects.
In medical, Fenner has a significant pipeline of new products and stands to benefit from the move to new and much larger facilities. The company has stated that this business segment has the potential to double its revenues organically in the next 5 years at current margins. This is a useful internally generated growth driver to add to the cyclical recoveries in other segments.
VALUATION
Optically the shares do not appear cheap on 22.3x PE for 2017e, or 15.4x EV/EBIT. However, we believe the earnings recovery could bring the operating profit level to £100m on a 3-5 year view. Assuming net debt and pension reduced to £125m, and applying an exit multiple of 10x EV/EBIT, this would take the share price to 450p, 58% upside from the current level.
The charts above shows the numbers of drilling rigs operational in the US. This declined sharply in 2015 and early 2016 due to the decline in the oil price. However, the rig count has inflected in the last 6 months and we believe that the more supportive stance of the new US administration should support continued recovery. In addition we understand that Fenner is enjoying an increased market share of new orders, probably due to a shift towards more high-pressure systems which suit Fenner’s product offering.
Furthermore we believe the drop-through ratio for this business is as high as 70%, meaning $10m of incremental revenue gives $7m incremental profit.
Other segments
In order to understand why we don’t consider 2016 or 2017e earnings numbers to be a good indicator of the true value of Fenner, it’s important to note the extent of the headwinds the group has faced in recent years. With most of these headwinds beginning to unwind, we see large headroom for earnings recovery.
The charts below show the revenue per customer segment, for the ECS (Engineered Conveyor Systems) and the AEP (Advanced Engineered Products) divisions. These show that the last few years have seen particularly sharp falls in the oil & gas segment for AEP, and also within the ECS division in the markets for thermal coal and for mineral ores, especially iron. We believe there are encouraging signs that equipment demand has bottomed out in the coal and iron ore segments and will begin to gradually recover. Meanwhile in oil and gas a brisk recovery already appears to be under way.