Big cyclical firms such as Royal Bank of Scotland Group and BHP Billiton both operate with commodity-style businesses.
Although large in terms of their market capitalisations, neither firm produces much added value to their product offerings. Go to Royal Bank of Scotland for a bank account or a loan and we might as well go to any banking company; buy a ton of iron ore or copper from BHP Billiton and we could buy it from any producer (ignoring geographical limitations).
Cyclically challenged
These giants might feel safe because of their size, but their longer-term share price charts tell a story of disappointed investors.
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Perhaps now, with the shares weak, Royal Bank of Scotland and BHP Billiton look attractive as cyclical bets on the next up-leg. Maybe. But there are better cyclical options on the stock market down the rankings with the smaller market capitalisations.
Rather than buying shares in out-and-out cyclical monoliths with undifferentiated products, maybe it’s better to look for a firm that adds more value to the final product it produces. That’s why I’m looking at premium building and precision engineering products supplier Alumasc Group (LSE: ALU).
Carving a focused niche
We happen upon Almunasc Group at an interesting period in the firm’s development. A trading update last month confirmed the sale of the larger of the company’s two engineering products businesses for £5.8 million in cash.
Alumasc plans to focus on its building products operations where the directors see the biggest opportunity to drive growth. I’m a big fan of concentration when it comes to business activities. Companies rarely outperform by trying to be all things to everyone. Trying to cover many sectors can dissipate energy, and a lacklustre business line can pull down overall trading results. By contrast, if a company focuses on a narrow area of operations there’s potential to become expert and efficient, which could lead to enhanced profitability.
To me, it makes sense for Alumasc to divest weaker areas of its business to do more of what’s going well. The firm’s recent business sale could mark an inflexion point from which future growth accelerates.
Serving the construction industry
Alumasc either manufactures or puts its name to a range of products serving the construction industry. Things such as blinds, louvres, balustrades, access covers, loft hatches, ventilation grills, water proofing and green roof systems, and external wall insulation rendering systems, to name but a few.
There’s no doubt that a large element of cyclicality will affect ongoing operations. The firm is nailing its colours to the mast of the construction industry, so we need to take a view on where that sector might be going over the next few years.
However, assuming that the next macro-economic crash isn’t imminent, Alumasc has opportunity to grow its niche operations within the wider cycle. The directors preferred route to expansion is by organic means, but they are not ruling out targeted acquisitions as well.
Valuation now
At a share price of 152p (market cap: £55 million) FTSE Fledgling constituent Alumasc Group trades on a forward dividend yield around 4.2%, and forecasters expect 2016 earnings to cover the payout almost three times. That level of cover suggests the directors are confident about achieving further growth, otherwise they’d probably hand the cash to investors rather than hanging on to it to reinvest in the business.
Meanwhile, the forward price-to-earnings ratio sits at just over eight, which seems undemanding when taken with that dividend payment and City analysts’ earnings growth predictions of 5% next year.
Alumasc’s shares have been trending up since the middle of 2012 — perhaps I’m not the only investor who thinks the firm’s ongoing development as a focused building products supplier and niche market operator could see the company outperform total returns from undifferentiated cyclicals such as Royal Bank of Scotland Group and BHP Billiton.
