Direct Equity Team: A Note from Bishopsgate
ROTORK UPDATE
Investment returns from the UK market continue to be dominated by banks, energy, and mining companies. Our primary focus remains identifying high-quality compounding businesses – companies with durable competitive advantages, robust balance sheets, and the ability to consistently reinvest capital at attractive rates. Globally, these sorts of businesses are being overlooked: they are not unlocking a groundbreaking technology such as AI, and they are not directly benefitting from higher commodity prices and higher interest rates. This means several companies that meet our high hurdle for quality are now at much more attractive valuations.
Rotork is an industrial business that, since the inception of the DEP Service, had always traded on a rating we have deemed too expensive to purchase. It currently trades on circa 16x Bloomberg expected earnings. Over ten years it has traded as high as 29x and usually can be expected to trade in the 20-25x range. The current rating has only been achieved in the last ten years in the depths of the COVID pandemic.
Rotork is a leading manufacturer of industrial actuators and flow control systems in the oil & gas, chemical and water industries. An actuator provides the physical movement to open or close a mechanical process; it is in affect the ‘muscle’ of a machine. In a very basic example, an actuator opens automatic doors of a supermarket. In Rotork’s case their products are used in industry where failure is not an option. Think nuclear power plants, gas pipelines, data centre cooling and oil storage tanks.
Rotork’s products represent a negligible amount of a facility’s total expenditure, yet their failure can result in catastrophic operational downtime and significant financial loss. Because of the financial and safety risks, all products are regulated and required to meet certain standards for quality and safety. These are difficult to obtain and create a barrier to entry for the industry, defending Rotork’s profits. 76% of Rotork’s profits come from product sales: the remainder is earned from high margin ongoing maintenance of existing products on site. As well as a regulatory barrier to entry, Rotork also has patents on their product designs to stave off competition.
Rotork operates an asset-light assembly model, outsourcing basic manufacturing to local suppliers. This allows Rotork to generate operating margins of around 20% and Return on Equity of 20%. The company maintains a strong net cash balance sheet, with secure free cash flow generation. This allows the business to invest organically for the future. It is also able to make bolt-on acquisitions while paying an attractive dividend yield of 2.8% and buyback its own shares to drive earnings per share growth.
Rotork benefits from long term growth trends of industrial automation, environmental electrification, and water infrastructure renewal.
One consideration of Rotork is exposure to its customer’s capital expenditure cycles. We typically prefer operational expenditure exposure because these costs are non-discretionary and are required for the everyday function of the end business. We are comfortable with this risk at Rotork because of its profitability and balance sheet strength, but also because of the essential nature of its products and maintenance. Upgrades can be delayed year on year, but they cannot be delayed indefinitely. The potential growth runway is attractive, particularly given the environmental pressure on their customer base to replace old pneumatic actuators that leak greenhouse gases.
Rotork represents a structurally sound, highly profitable business with a defensive market position. While it is not immune to economic cycles, its strong balance sheet and recurring revenue model suggests it remains a high-quality candidate for long-term capital preservation and steady growth.
This article was prepared by Tom Waters, one of our Investment Managers.
