I’ve been searching for unusual ways to tap into the commodities boom. After trawling through companies on the FTSE 100, I came across Weir Group (LSE: WEIR), the mining-equipment specialist.
This specialised engineering giant offers investors both an industry-leading position and long-term growth story.
But despite its record order book and upbeat trading statement, Weir’s shares have slumped more than 30% since its peak in February.
In my view, Weir’s current forecast P/E of 10 provides a tantalising buying opportunity into a first-class engineering company with significant upside potential.
Collapse in gas prices
Weir makes pumps and valves for the mining, power and oil & gas sectors. One of its biggest growth areas is in helping firms access the huge oil and gas deposits embedded in shale rock through a controversial technique called fracking.
However, US natural gas prices have fallen to a decade low of late – and are down more than 80% since their all time high in 2005. In 2011, the oil and gas sectors accounted for 38% of Weir’s revenues. And Weir provides one in every two high-pressure pumps used in the North American shale market.
With Weir geared towards the shale industry, there have been fears that low US gas prices could dent demand for unconventional oil & gas resources.
Anxieties over Weir’s exposure to the shale industry have led the shares to become a favourite among short sellers. According to Data Explorers, just over 15% of Weirs shares were on loan as of late march, where as the average short position for the FTSE 100 remained steady at just above 1%.
But, I believe this shorting is an audacious move by investors which could prove potentially fatal – at least in their wallets!
During 2009, I recall investors built up an equally large short position in Aggreko (LSE: AGK), and found themselves caught out when the firm announced a jump in profits.
It is worth remembering that Weir’s mineral division, on which it is a world leader in slurry pumps, accounts for more than 50% of operating profits. It is the core of its business, not the oil & gas division.
On the other hand this leaves Weir exposed to the mining sector, and a reduction in capital spending by the mining companies could reduce demand for its infrastructure equipment in the short-term.
The long-term case
Nevertheless, I believe Weir’s recent falls have been largely overdone for three reasons. Firstly, the structural case remains firmly intact. Weir CEO Keith Cochrane succinctly summarised the long-term case for Weir by saying “the company is being driven by a cycle of economic growth linked to the commodities boom and the industrialisation of countries such as China and India”.
Secondly, Weir is today much more protected from the economic downturns as a result of its growing after-market service. This consists of servicing and maintaining the pumps sold to mining companies. Service and maintenance now account for nearly half of its sales. Moreover, it is the after-market service which yields a much higher margin than simply selling infrastructure equipment.
Weir reminds me of Rolls Royce, which has dramatically grown its servicing operations, providing the vital cushion against these difficult economic times. Financial publishing firm ‘Citywire’ asks the question: Is Weir the Rolls Royce of mining?
Plenty of growth
Thirdly, being a key supplier to the booming commodity industries has done wonders to Weir’s growth rates and established a very attractive track record. The firm has tripled its pre-tax profits during the last five years and earnings are forecast to expand at double-digit pace during the next few years.
Enthusiastic earnings predictions continued at a city presentation in June, when Weir CEO Keith Cochrane set an ambitious target of doubling profits in its mineral division (the biggest contributor of profits) by 2016.
Elsewhere, while the shares currently yield a modest 2.2%, the firm has managed to grow its dividends consistently since 2000 – doubling the payout between 2007 and 2011. Today, Weir presently maintains its progressive dividend policy.
All told, I believe Weir’s potential isn’t reflected in its current share price. With key structural themes underpinning its growth, the company makes a very attractive long-term investment.