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Johnson Matthey - virus hits, but profits better than feared

Nicholas Hyett, Equity Analyst | 19 November 2020 | A A A
Johnson Matthey - virus hits, but profits better than feared

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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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Johnson Matthey's reported a 2% increase in revenue during the first half, reaching £7.0bn. However, that was largely down to higher precious metal prices, with sales excluding precious metals down 20% to £1.7bn. Underlying operating profits fell 42% to £151m, almost entirely driven by a substantial decline in automotive catalysts.

The board announced an interim dividend of 20p per share, down 18% year-on-year.

The shares rose 3.1% in early trading.

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Our view

The coronavirus outbreak led to the shutdown of huge swathes of the global automotive industry. As the leading manufacturer of catalytic converters - the clever bits in car exhausts that strip out the worst emissions - that has inevitable consequences for Johnson Matthey (JMAT).

A strong recovery in Asia, and particularly China, will provide some reassurance that sales can bounce back. A buoyant platinum price has also provided a useful boost - especially as improvements to the refining process have seen the group shrink its precious metal inventory. That's part of a wider drive to improve efficiency by consolidating manufacturing operations and improving procurement practices.

However, JMAT has other strings to its bow, strings where the coronavirus impact hasn't been the same.

The natural resources and health businesses take JMAT's chemical knowhow and apply 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.

In reality, the coronavirus outbreak is little more than a bump in the road for the group. However, that bump is badly timed. As global concern about emissions has risen, and regulations have tightened, catalytic converters have been able to claim an increased share of the total car spend. Unfortunately concern has now reached such a pitch that conventional combustion engines are in danger of being abandoned altogether.

Global automotive manufacturers are planning a $300 billion surge in spending on electric technology over the next 5-10 years. Since electric cars don't have exhausts that could eliminate the need for catalysts altogether. JMAT's answer is to re-engineer itself as a leading supplier of materials for batteries and hydrogen fuel cells. The problem is that both the pace and direction of emission free car technology remain unclear.

A rapid shift to fully electric vehicles would be bad news. But increasingly stringent regulation and widespread uptake of hybrid vehicles would be fantastic - since catalytic converters would still be required, and there would be opportunities to sell into the battery supply chain as well. Unfortunately recent announcements, like the UK ban on new petrol and diesel car sales by 2030, suggest the former is more likely.

The other potential pitfall is technological.

The group's 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 some way off though, with the first plant expected to open in 2021/22.

However, in a rapidly changing industry there's no guarantee JMAT's picked a winning formula, and development is expensive. Total sales from the Alternative Powertrain are a tenth of what's achieved in Clean Air even at the current reduced level. Until customers start to put real money into buying eLNO in volume it's difficult to say whether JMAT's pivot will bear fruit.

Overall JMAT feels a bit in limbo at the moment.

Auto-catalysts are theoretically in the driving seat, but coronavirus has slammed on the brakes while the shift towards electric vehicles probably gives the division a limited life. As things stand the other divisions are too small to really move the dial. Whether JMAT will ultimately become a dominant player in the battery market is an open question, but we struggle to find its position compelling at present.

Johnson Matthey key facts

  • Price/Earnings ratio: 14.6
  • 10 year average Price/Earnings ratio: 14.1
  • Prospective dividend yield (next 12 months): 2.6%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Trading Update (Constant Exchange Rates)

The Clean Air division, which includes the automotive catalysts business, saw sales fall 27% in the half to £1bn. Operating profits fell 56% to £77m. The decline was driven by weakness in Europe and the Americas, across both light and heavy duty vehicles, although sales recovered as the half progressed. That was partly offset by growth in Asia, particularly China.

Efficient Natural Resources sales fell 10% to £446m, with operating profits down 12% to £81m. The group put the tough half down to the effect of COVID-19, and the inherent cyclicality of methanol and ammonia catalysts.

Sales in Health grew 8% to £119m, the only division to show growth. However, operating profits fell 21% to £15m, as revenue mix negatively impacted profitability - specifically the cancellation of a lucrative 'innovators' contract.

New Market sales fell 8% but moved from an £8m loss last year to a £5m profits this half. That follows the non-recurrence of an £8m impairment last year relating to the eLNO demo plant. The group has begun engineering design work on its second commercial eLNO plant. The sales decline reflects disruption to the battery materials business caused by COVID-19.

At the non-underlying level the group reported £78m of impairments and restructuring costs as it looks to become more efficient. The group has delivered £140m of annualised cost savings so far, mainly through procurement initiatives, and plans to hit £225m by 2022/23.

Johnson Matthey reported free cash flow of £256m, compared to an outflow in the same period last year. That reflects improved inventory management of precious metals, with the overall value of precious metal inventory falling despite an increase in prices.

Net debt stood at £0.9bn at the end of the half, down from £1.1bn at the start of the financial year, equivalent to 1.6 times cash profits (EBITDA).

Given continuing uncertainty the group has decided not to give detailed guidance for the remainder of the year.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

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