Stock pick: Improved IMI's undervaluation offers comfort in a volatile market
Under the leadership of Roy Twite, IMI, the British capex manufacturer, has gradually but surely become an improved business. The ingredients include initiatives to drive organic growth, well-thought-out acquisitions, less cyclicality, better margins and, last but not least, a very competent management. However, when we look at the market’s perception of today’s IMI, we sense a valuation gap and believe that IMI deserves a higher valuation. As such, IMI is worth a look at the current price.
IMI designs, manufactures and services products that allow for a precise movement and control of fluids. The company supports some of the critical industries across more than 50 countries with its workforce of close to 11,000 people. It operates through three main divisions with each division dedicated to catering specific needs.
Analysis
IMI Stock Price
Organic growth encouraged by the Growth Hub – Since 2019, IMI has placed an increased emphasis on innovation to drive organic growth. Under this strategy, the mandate for its employees is to identify, test and learn about areas that have unmet needs and/or address acute problems with ingenious solutions. The Sprint Teams probe such opportunities. Once a Sprint Team comes up with a proposal, a business case is developed. However, it is scaled only after being validated through customer commitments (firm orders). So, through this ‘Growth Hub,’ IMI is tapping into viable markets with higher growth. And this strategy is now bearing fruit.
Inorganic growth helped by prudent acquisitions – Over the last three years, IMI has successfully formed the core of each of its three divisions and has logically moved from divestments to acquisitions while retaining its familiar disciplined approach. IMI expects its targets to address growth markets with scalable products and a reasonable moat. Financially, it expects its acquisitions’ ROIC to exceed the WACC by year 3. So far, IMI has made three acquisitions in line with these criteria and at reasonable valuations. This inorganic growth strategy has lent balance to IMI’s overall growth objectives.
More aftermarket, less cyclicality – IMI’s Critical Engineering division (35% of total 2022 sales) harbours a margin accretive aftermarket business. This business is highly margin accretive with margins in mid-double digits (AV assumption) and strong customer retention rates (upwards of 90%). IMI has been steadily growing the aftermarket’s share in its order book from 47% in 2017 to 54% in 2020 to 58% in 2022. The management’s aim is to make the aftermarket 65% of Critical’s business and we expect this to eventually make the business less cyclical despite the company’s exposure to Oil & Gas end-markets.
Restructuring efforts have paid off – Over the last couple of years, IMI has been restructuring its footprint mostly across its two big businesses – Precision and Critical. The cost of these efforts has been in low to mid-double-digit millions with benefits in low double-digit millions. What has impressed us the most though, is that these efforts have delivered on their promises, boosting both margins and the management’s credibility. According to the management, the bulk of the restructuring will be completed by 2024 and, in our view, this will support improved margins.
Medium-term targets revised upwards – With its H1 23 results, IMI also unveiled its revised through-cycle financial framework wherein it expects organic growth of 5%, an adjusted operating margin of 20%, a cash conversion of 90% and a return on invested capital of >12%. Except for the margin target, the other targets are new and provide additional transparency to IMI’s ambitions. Note that the organic revenue growth target is higher than previously discussed in capital market events and is, hence, a clear positive in our view.
Impact
A market valuation that ignores the recent improvements – Based on the points highlighted above, we firmly believe that IMI is currently undervalued in absolute as well as relative terms. The company is currently trading at a 2023E EV/EBIT multiple of 13.5x versus a 10-year average of 15.2x. Similarly, on the 2023E P/E, IMI is trading at 15.4x versus 10-year average of 20.5x. Hence, in our opinion, this valuation gap is unjustified for a quality business with c.5% FCF yield and a c.2% dividend yield.
Analysis
IMI Stock Price
Organic growth encouraged by the Growth Hub – Since 2019, IMI has placed an increased emphasis on innovation to drive organic growth. Under this strategy, the mandate for its employees is to identify, test and learn about areas that have unmet needs and/or address acute problems with ingenious solutions. The Sprint Teams probe such opportunities. Once a Sprint Team comes up with a proposal, a business case is developed. However, it is scaled only after being validated through customer commitments (firm orders). So, through this ‘Growth Hub,’ IMI is tapping into viable markets with higher growth. And this strategy is now bearing fruit.
Inorganic growth helped by prudent acquisitions – Over the last three years, IMI has successfully formed the core of each of its three divisions and has logically moved from divestments to acquisitions while retaining its familiar disciplined approach. IMI expects its targets to address growth markets with scalable products and a reasonable moat. Financially, it expects its acquisitions’ ROIC to exceed the WACC by year 3. So far, IMI has made three acquisitions in line with these criteria and at reasonable valuations. This inorganic growth strategy has lent balance to IMI’s overall growth objectives.
More aftermarket, less cyclicality – IMI’s Critical Engineering division (35% of total 2022 sales) harbours a margin accretive aftermarket business. This business is highly margin accretive with margins in mid-double digits (AV assumption) and strong customer retention rates (upwards of 90%). IMI has been steadily growing the aftermarket’s share in its order book from 47% in 2017 to 54% in 2020 to 58% in 2022. The management’s aim is to make the aftermarket 65% of Critical’s business and we expect this to eventually make the business less cyclical despite the company’s exposure to Oil & Gas end-markets.
Restructuring efforts have paid off – Over the last couple of years, IMI has been restructuring its footprint mostly across its two big businesses – Precision and Critical. The cost of these efforts has been in low to mid-double-digit millions with benefits in low double-digit millions. What has impressed us the most though, is that these efforts have delivered on their promises, boosting both margins and the management’s credibility. According to the management, the bulk of the restructuring will be completed by 2024 and, in our view, this will support improved margins.
Medium-term targets revised upwards – With its H1 23 results, IMI also unveiled its revised through-cycle financial framework wherein it expects organic growth of 5%, an adjusted operating margin of 20%, a cash conversion of 90% and a return on invested capital of >12%. Except for the margin target, the other targets are new and provide additional transparency to IMI’s ambitions. Note that the organic revenue growth target is higher than previously discussed in capital market events and is, hence, a clear positive in our view.
Impact
A market valuation that ignores the recent improvements – Based on the points highlighted above, we firmly believe that IMI is currently undervalued in absolute as well as relative terms. The company is currently trading at a 2023E EV/EBIT multiple of 13.5x versus a 10-year average of 15.2x. Similarly, on the 2023E P/E, IMI is trading at 15.4x versus 10-year average of 20.5x. Hence, in our opinion, this valuation gap is unjustified for a quality business with c.5% FCF yield and a c.2% dividend yield.
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