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Johnson Matthey - Sales rise but profits and cash remain weak

Nicholas Hyett | 21 November 2019 | A A A
Johnson Matthey - Sales rise but profits and cash remain weak

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Johnson Matthey Plc Ord GBP1.109245

Sell: 3,119.00 | Buy: 3,121.00 | Change 41.00 (1.33%)
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Underlying sales rose 3% at constant exchange rates to £2.1bn, driven by growth in the catalytic converter and industrial catalyst businesses. However, increased shipping and manufacturing costs associated with the opening of a new plant in Poland meant underlying operating profits fell 5% to £265m.

The interim dividend rose 5% to 24.5p, despite free cash flow deteriorating and net debt climbing substantially.

The shares fell 6.8% in early trading.

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Our view

There are three distinct parts to the Johnson Matthey (JMAT) story.

First and foremost, it's a leading producer of catalytic converters - the clever bits in car exhausts that strip out the worst emissions. That business is expected to grow over the next decade as regulators tighten emission rules - particularly in China and Europe. We think it's an attractive business, although significant exposure to platinum prices can make it volatile.

The smaller natural resources and health businesses take JMAT's chemical knowhow and applies it elsewhere. Health in particular is expected to deliver 'break out' growth over the next decade - although it will remain small compared to the catalysts business.

But it's the batteries business that generates real excitement. Global automotive manufacturers are planning a $300 billion surge in spending on electric technology over the next 5-10 years. The electrification of vehicles is being taken seriously by traditional players in the sector, not just the likes of Tesla. That would potentially eliminate the need for catalysts, so JMAT is looking to re-engineer itself as a leading supplier of materials for batteries.

The problem is that both the pace and direction of electric car development remains unclear.

A rapid shift to fully electric vehicles would be bad news. But increasingly stringent regulation and widespread uptake of hybrids vehicles would be fantastic - catalytic converters would still be required, but there would be opportunities to sell into the battery supply chain as well.

The other potential pitfall is technological. There's no guarantee JMAT's picked the winning formula for batteries. Until recently it had been focussed on lithium iron phosphate batteries, but changes to regulation in China mean these have fallen out of favour, knocking JMAT battery material sales.

Fortunately its foray into lithium nickel alternatives seems to be getting some good results. The eLNO product has had a warm reception from potential customers and a trial plant is up and running. Commercial production of eLNO is still years away, with the first plant expected to open in 2021/22.

Overall JMAT feels a bit in limbo at the moment. Auto-catalysts are firmly in the driving seat where profits are concerned, but the long term shift towards electric vehicles probably gives it a limited life. Whether it will become a dominant player in the battery market is an open question, but we struggle to find its position compelling at present. Perhaps it's no surprise then that the shares currently trade on 13.2 times forward earnings, below their longer run average, with a prospective yield of 2.9%.

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Half year results (Constant exchange rate)

Sales in the Clean Air division, which makes automotive catalysts, rose 4% to £1.4bn thanks to growth in Light duty vehicles (LDV). Profits slipped 9% to £179m reflecting the phased introduction of the new Polish plant designed to service increased European LDV demand. Full year operating profits are now expected to be weaker than last year.

Efficient Natural Resources saw sales rise 4% to £496m, benefitting from higher metal prices in the Pgm Services business, which recycles platinum group metals. Operating profits rose 6% to £94m. Health saw sales fall 9%, although operating profits rose 21% to £18m thanks to increased efficiency.

The New Markets business saw sales rise 5% thanks to a good result in fuel cells, although the division remains slightly loss making overall. Development of the first commercial eLNO battery material plant is on track.

JMAT reported a free cash outflow of £382m in the half, largely due to increased platinum prices and also increased capital expenditure. As a result net debt rose £452m year-on-year to £1.5bn, above the groups long term target.

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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.