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Johnson Matthey - virus hits profits, cost control a focus

Nicholas Hyett, Equity Analyst | 30 March 2020 | A A A
Johnson Matthey - virus hits profits, cost control a focus

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Johnson Matthey Plc Ord GBP1.109245

Sell: 2,258.00 | Buy: 2,261.00 | Change 19.00 (0.85%)
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Prior to the coronavirus outbreak Johnson Matthey (JMAT) had been on course to deliver results in line with market expectations for the financial year ending 31 March 2020. However, the pandemic has led to a deterioration in some end markets, particularly automotive, and the group now expects to miss expectations this year.

The group is taking steps to manage costs and cash. Leverage at the year end, as measured by net debt to cash profits (EBITDA), is expected to be similar to that reported in September, thanks to a reduction in the amount of platinum the group holds.

The shares rose 4.8% in early trading.

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Our view

The coronavirus outbreak has led to the shutdown of huge swathes of the global automotive industry - including all carmaking facilities in Europe. As the leading manufacturer of catalytic converters - the clever bits in car exhausts that strip out the worst emissions - that has inevitable knock on affects for JMAT.

Clean Air, the division which includes auto-catalysts, accounted for 69.4% of operating profit. Like many others the focus of the division has turned to cash preservation. The high price of inputs like platinum mean a large chunk of the catalyst businesses costs are variable, so lower production automatically means lower costs. That still leaves some £580m of annual fixed costs though.

Fortunately JMAT has other strings to its bow, and the coronavirus impact here hasn't been the same.

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 and has weathered the current storm well - although it will remain small compared to the catalysts business.

The batteries business is also interesting, although it doesn't yet generate significant sales. 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. However, 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.

In the short term the group will be leaning heavily on its balance sheet to keep the wheels turning. The group has access to a sizeable pool of cash, but if the automotive shutdown looks like it will drag on the group could yet have to trim its dividend to shore up its position. It's notable shareholder returns didn't get a mention in the full year trading update.

Overall JMAT feels a bit in limbo at the moment.

Auto-catalysts are theoretically in the driving seat, but coronavirus has slammed the brakes on and the long term shift towards electric vehicles probably gives the division a limited life. Whether it will ultimately become a dominant player in the battery market is an open question, but we struggle to find its position compelling at present.

It's perhaps no surprise the shares trade on a PE ratio of 7.7 times, 45% below their long run average.

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Full Year Trading Update

JMAT expects the coronavirus outbreak to negatively impact sales by £50m in the current financial year. That reflects reduced demand in Clean Air and £20m of delayed shipments as a result of logistics challenges throughout the business.

The closure of automotive plants around the world is negatively affecting results in the Clean Air division. The group has closed most of its manufacturing facilities as a result, although that excludes China where operations are ramping back up. 75% of costs in the Clean Air business are variable.

Efficient Natural Resources has not seen a material fall in demand, although some companies have delayed orders due to supply chain issues. Chinese demand is starting to improve, and platinum refineries continue to operate albeit at lower capacity. The Health and Medical Devices Components businesses have seen no decline in demand.

Cash preservation efforts include work to lower inventory, collect receivables and reduce the cost base. The group is also delaying a number of discretionary projects. Working capital tied up in platinum group metals has fallen by £200m.

The group has around £250m of cash on hand, with access to £600m of liquidity from a revolving credit facility, and £130m from other facilities. Net debt to EBITDA is expected to be the region of 2.1 times at the end of the 2019-2020 financial year.

The group does not feel able to give guidance on performance for the 2021 financial year.

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