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Johnson Matthey - An improved second half, but progress is slow

Nicholas Hyett | 1 June 2017 | A A A
Johnson Matthey - An improved second half, but progress is slow

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Johnson Matthey Plc Ord GBP1.109245

Sell: 3,180.00 | Buy: 3,182.00 | Change 14.00 (0.44%)
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The weaker pound drove a significant increase in reported revenues at Johnson Matthey (JMAT), up 12% to £12bn. Operating profits of £513m were flat once the effect of currency movements are excluded.

JMAT's final dividend rises 5% to 54.5p per share, taking the full year payment to 75p. The shares fell 2.4% in early trading.

Our View

Johnson Matthey is, first and foremost, one of the world's leading producers of catalytic converters - the clever bits that go in car exhausts to strip out the worst emissions.

As recent weak performance in the US shows, the vehicle market is cyclical, exposing JMAT to downturns. But the ever-tightening regulation around vehicle emissions has made catalysts increasingly complex, and an increasingly complex product means more pricing power. Since catalysts account for a growing proportion of total car costs, JMAT has tended to grow faster than its customers. With competitors few and far between, operating margins are strong.

Unfortunately, the drive to reduce emissions is now threatening the combustion engine itself, and that's not good news for Johnson Matthey. If we see a rapid switch towards wholly electric vehicles it would hurt, since they don't need catalysts.

JMAT has responded with a shift into battery technologies. The division broke even for the first time in FY16 and is heavily involved in the technologies that will enable the mass adoption of all-electric cars in the long term. The danger with launching yourself into a whole new technology of course, is that is that while it might well be a great place to be in the long term, there's no guarantee you're the ones who'll crack it. Progress is slow, but it's something to watch out for going forwards.

Demand in the smaller divisions, serving industrial process markets with catalyst technologies, was hit by the fall in the oil price, and profits in these divisions have proven volatile in the past. Conditions are improving, but are still a side show. For the time being catalysts are in the driving seat and although that means overall performance is likely to be uninspiring in the near term, there is little sign of demand coming to a screeching halt.

Johnson Matthey currently trades on around 14.3 times forward earnings, a fraction below the longer run average of 14.5 times, and offers a prospective yield of 2.7%.

Full Year Results (Constant Exchange Rates)

Flat full year operating profits represent a 4% improvement in second half trading, after the first half saw profits decline 3%.

Across the year as whole, Emission Control Technologies, which accounts for 62% of profits, saw 4% sales growth, with operating profits up 2%. Sales in the division outperformed vehicle growth in nearly every market. European Light Duty Vehicle put in a particularly notable performance, up 13%, although the downturn in the US continues to weigh on otherwise buoyant Heavy Duty Diesel sales.

Process Technologies, 18% of group operating profits, saw profits rise 9% on a flat sales performance thanks to £18m in cost savings achieved as part of last year's restructuring programme. Precious Metal Products benefited from higher platinum prices, with a 13% rise in refining and recycling sales contributing to the 17% growth in underlying operating profits. The division now accounts for 17% of group profits.

Fine Chemicals (13% of group profit) was the weakest performing division in the year, with operating profits down 23%. The division, which manufactures active ingredients for pharmaceutical products, saw a significant downturn in sales of its higher margin ADHD products.

New Businesses Businesses remains loss making, although losses reduced from £17.9m to £14.4m. The group continues to invest heavily in the batteries business, which saw sales rise 2% overall. However, the key Battery Materials business saw sales fall 2% as tax changes in China impacted demand for lithium ion phosphate battery materials. The group is investing in nickel rich high energy battery materials.

Net debt over the year fell to 1.1 times earnings before interest, tax, depreciation and amortisation (2015/16: 1.2 times). Next year is expected to see sales growth broadly in line with the 6% delivered in the second half of 2016.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.