James Faulkner on Pressure Technologies: more than just a metal basher

Pressure Technologies (PRES) has long been mistaken for a boring ‘metal basher’ with less than enticing future prospects. However, the market is beginning to realise that those assumptions are misplaced, and a nascent re-rating is underway.

In fact, Pressure Technologies stands at the cutting edge of several niche engineering sectors with terrific growth potential. It has also shown itself to be an astute acquirer of companies, and acquisitions remain a part of the strategy going forward.

In a similar manner to the very successful consolidator Judges Scientific (JDG), Pressure Tech acts as an attractive ‘umbrella’ platform for small but nevertheless very capable businesses operating in niches within the engineering sector. Profits are set to more than quadruple over the period 2011-15 and investors are beginning to realise that Pressure Technologies is indeed a growth stock. The re-rating could have a long way to go.

Reassuringly old…

The group comprises three key trading divisions: Chesterfield Special Cylinders (CSC), Chesterfield BioGas (CBG) and Engineered Products.

Chesterfield Special Cylinders (CSC) has been a leader in the design, development and manufacture of high pressure seamless steel gas cylinders for over 100 years. Its origins trace back to The Universal Weldless Steel Tube Company Limited, which was formed in London in 1897 and later acquired in 1906 by Chesterfield Tube Company Limited. Under a succession of owners, the business was at the forefront of all major technical advances in seamless steel cylinders throughout the 20th century. CSC supplies Air Pressure Vessels (APVs) for oil rig motion compensation systems and deepwater offshore platforms, as well as breathing air cylinders and gas storage. It also offers a range of in-situ inspection services that effect reductions in cost and time for statutory pressure vessel retesting. In addition to the oil & gas market, CSC also has a world-class reputation in the submarine sector, delivering design, development and retesting services to a number of the world’s navies.

Next up, the Engineered Products division provides a wide range of control and testing equipment for drilling systems and precision engineered valve wear parts used for flow control in the subsea and surface oil and gas industries. The division also supplies a range of test equipment for valves, fittings and hoses into the industrial gases market. Looking to the longer term, the group is monitoring the developments in the North American Light Tight Oil (LTO) and the hydraulic fracturing market in North America and the UK, to assess where opportunities for its products and technology development may arise.

The smallest trading division, albeit rapidly growing in importance, is Chesterfield BioGas (CBG), which was established in 2008 following the signing of a co-operation agreement with Greenlane Biogas Limited, the world leader in biogas upgrading. In 2010, CBG installed the UK’s first biogas upgrader supplying biomethane to the national grid at a Thames Water site in Didcot, followed by the delivery of a second upgrader in October 2012. The market has been slow to develop due to Government inertia on subsidies and gas quality standards. However, following publication of the Renewable Heat Incentive in 2012 and confirmation of quality standards in 2013, Chesterfield BioGas has seen a significant increase in interest from large utility companies.

Deepwater Horizon highlights the risks of cutting corners…

The deepwater offshore drilling sector has been through a rough period following the Deepwater Horizon disaster in the Gulf of Mexico, but activity is starting to pick up. In fact, Goldman Sachs predicts spending on ultra-deepwater projects will grow 40% annually through 2016, which is very good news for Pressure technologies. The bottom line is that most of the easy to access onshore oil has already been got at and companies are increasingly having to look harder and farther (and deeper!) for new supply.

Brazil, for example, is exploring untapped reserves in the Santos Basin, located more than 180 miles off the coast of Sao Paulo, where the water has depths of almost one mile (5,280 feet); China is planning to produce 1 million barrels of oil equivalent per day by 2020 by drilling offshore; and oil companies in Japan, Africa, Thailand, and India are ramping up spending to drill for oil off their coasts. Unless someone creates some cheap and abundant super energy in the next couple of years (unlikely), this trend towards offshore is likely to continue for some time.

However, the Deepwater Horizon disaster also increased concerns over the safety of deepwater drilling, which has brought oil companies under increasing regulatory scrutiny. This is also good news for Pressure Tech, which is putting a lot of emphasis on growing its services business. Cylinders already need to be inspected every 10 years for efficiency and safety reasons, but after Deepwater Horizon no company will want to cut corners, or indeed give the impression of cutting corners, in this area. The firm’s “in-situ” testing programme can now perform inspections onboard platforms to the same standards as it would do onshore, and Pressure Tech recently reported strong growth in this area of the business.

Other areas where the firm is looking at ways its expertise can add value include the nascent shale gas “fraccing” industry in the US and, potentially, the UK. In the US, it is well placed to access this market through its rapidly growing Hydratron business, while in the UK, it benefits from little competition in its markets.

Elsewhere, the Alternative Energy division is really starting to come into its own, with management recently witnessing “a step change in the market for biogas upgrading, which is moving from small scale, proof of concept projects to large scale plants, which deliver commercial returns to our customers.” Natural gas and hydrogen applications also have the potential to surprise on the upside, albeit from a low base.

A platform for growth…

Acquisitions are aimed at adding areas of technical capability and exploiting opportunities to utilise the group’s infrastructure to drive growth. Last December’s acquisition of a 40% stake in GTM (along with an option to purchase another 40%) will enable Pressure Tech to combine the expertise of the design and manufacture of high pressure gas cylinders in its subsidiary Chesterfield Special Cylinders (CSC), with GTM’s expertise in the production of light-weight composite cylinders and to develop and expand GTM’s product range for use in the United States and subsequently further afield.

Management believes that the market for GTM in the US is set for rapid expansion, not least because of the gas revolution currently in full swing in the US. Interestingly, whilst there are a number of businesses in competition with GTM, no company has a dominant position in the US and the well known and respected Kelley brand gives GTM the potential to be a major player in the US and beyond.

March saw the acquisition of Roota Engineering Limited, a long established, privately owned business, specialising in the manufacture of bespoke engineered products for the oil and gas industry. Roota’s niche lies in the production of highly complex products, with a specialism in machining exotic alloys to exacting tolerances. It has modern manufacturing facilities, located close to Pressure Technologies’ existing cylinder business and an impressive “blue chip” customer base.

As with many previous acquisitions, the rationale behind this one was to provide Roota with a growth platform. Pressure Tech’s Al-Met subsidiary serves the same oil and gas market and produces similar, albeit larger and more complex products. It should therefore serve as a springboard for cross selling opportunities across the two customer bases. Pressure Tech’s established reputation and networks within the industry will also help to win new customers and develop export markets for Roota.

Strong trading & a net cash position leave room for further upside…

The firm recorded a 53% rise in underlying (i.e. before acquisitions costs & related amortisation) operating profit to £2.17 million for the half-year to March, achieved on the back of revenue growth of 21% to £19.9 million. This fed through to a 38% increase in underlying earnings per share to 12.7p, and the interim dividend was increased by 8% to 2.8p per share. Cash conversion was strong and closely tracked operating profit, with £2.4 million generated from operations (£1.9 million after finance costs). A net £10.9 million was consumed in investing activities (principally the acquisition of Roota Engineering), but a recent placing raised just over £16 million, leaving the net cash position at £10.5 million at period end.

As a result of the better-than-expected performance, house broker Charles Stanley has upgraded its FY14 normalised pre-tax profit forecast by 18.5%, from £5.4 million to £6.4 million. Despite this upgrade, the broker said it continues to believe that its forecasts are “appropriately conservative for a group that trades on a healthy, but equally justified, premium”.

On the new estimates, which include a slightly lowered tax rate assumption, the shares trade on a prospective earnings multiple of 18.3x, 15x and 13x for FY14, FY15 and FY16 respectively. Although the broker notes that this represents a slight premium to the broader engineering sector, earnings growth in the wider sector compares poorly to the near 40% growth in EPS expected of Pressure Technologies.