Rotork slump is warning to others

Plunging oil prices are having a major impact not just on drillers, but on the companies that supply them. Under pressure to slash costs, exploration companies are deferring projects or scraping them altogether. It's why normally resilient businesses are warning of a big hit to profits this year. Valve control systems firm Rotork joined the list Thursday and, judging by the tone of its announcement, it may not be the last.

"The trading environment in the second half to date has been challenging across most of our key markets and geographies," it said. "We have seen an increased number of project deferrals and cancellations, with trading in August particularly weak."

Although Rotork is being asked to quote for plenty of jobs, "the timing of order placement and product delivery remains difficult to forecast". A month after saying a similar thing at what were actually decent interim results, chief executive Peter France has confirmed that "a number of orders expected to be placed in the third quarter have been delayed with delivery now anticipated in 2016, impacting the group's results for the current year".

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Cost savings will not offset the shortfall, which means revenue for the year is now expected to be in the range of £530-£555 million with adjusted operating profit of £120-£130 million. That's down about 12% from previous expectations of £140-£145 million. Investec Securities now thinks Rotork will make adjusted pre-tax profit of £118 million in 2015 and not much more next year. That gives adjusted earnings per share (EPS) of 10p, putting the shares on about 18 times forward earnings, a discount to the historical average, but deserved given expectations of flat growth through 2016.

Oil and gas work accounts for well over 50% of Rotork's business, much of which is generated by its fluid power division, so it's hardly surprising that profits have suffered. It's something the market began pricing in this May since when the share price has fallen 19%. They've plunged a further 16% Thursday to their lowest in almost four years and, given oil prices are widely tipped to remain depressed for many months, there could be further pain here.

Remember, just a few weeks ago Rotork paid £125 million for Manchester-based Bifold, which supplies pneumatic and hydraulic instrument valves and parts to the oil and gas industry. Subsea and wellhead control systems are a speciality, but current conditions could delay any benefits.

This means that despite being a solid, high-margin operator, Rotork is in for a rough ride, and the shares could get even cheaper. Investec Securities certainly thinks so. Rotork has always traded at a premium to the sector, and the broker still believes a 30% premium to average enterprise value/cash profit ratios is appropriate. Still, it now reckons the shares are now a 'sell' and worth just 170p based on the warning, Bifold acquisition and sector de-rating.

That spells bad news for other companies heavily exposed to oil and gas. Suppliers of high-tech kit like Weir, IMI and Smiths Group through its John Crane division are all vulnerable, as are Renishaw and Spirax-Sarco to a lesser degree. Weakness in China also remains a clear threat.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.