Spirax - a Story about Steampower
Steam power is best known for its role in early locomotives and the Industrial Revolution. Yet, far from being a technology of the past, steam remains an essential part of modern industry, valued for its efficiency, flexibility and relatively low cost. It has also become a hot topic for the DEP team in recent weeks as we have researched our latest investment, Spirax Group. Its Steam Thermal Solutions division accounts for almost half of group revenue and more than half of group profits, making the humble steam system central to the investment case.
The importance of efficient steam systems becomes clear when looking at the demands faced by energy-intensive organisations. Energy may not be the first cost that springs to mind when considering a hospital’s operating budget, yet it accounts for around 15% of running costs. With budgets under increasing pressure, hospitals need to find ways to operate more efficiently and free up resources for patient care. A good example is the Lanesborough wing of the 1,000-bed St George’s Hospital, which is now home to five Spirax EasiHeat systems. By delivering heating and domestic hot water more efficiently, while requiring less maintenance, the systems save the hospital around £45,000 a year.
The Heinz factory in Wigan is the largest food factory in Europe. Spanning 55 acres, it produces canned soups, baked beans and pasta for the UK and European markets. Keeping these production lines running requires a huge amount of energy: the on-site energy centre generates up to 140 tonnes of steam every hour. Heinz asked Spirax Group to survey the site and identify ways to reduce its energy consumption and carbon footprint. A Spirax sales engineer designed a steam-trap solution that reduced energy consumption by 4%, equivalent to around 200 tonnes of carbon emissions each year.
These are two of many examples of the value Spirax can deliver for its customers. Its offering extends beyond the initial product sale to include repairs and maintenance, which account for around 45% of group revenue. Spirax operates across three main segments: Steam Thermal Solutions, Electric Thermal Solutions and Watson-Marlow. Across these businesses, the objective is consistent: helping customers make their industrial processes more energy efficient, safer and cheaper to run. This can be particularly valuable when compared with alternative technologies; for example, heating oil introduces additional flammability risks, while hot-water systems can require more energy and maintenance.
The critical nature of these applications also makes Spirax's revenues unusually resilient. Around 85% of group revenue comes from customers' operating budgets, which fund the day-to-day running of their businesses, rather than capital expenditure, which can often be deferred. This gives Spirax a degree of pricing power: over the past 20 years, the company has consistently increased prices ahead of inflation while continuing to grow sales volumes. Furthermore, around 60% of sales come from defensive industries, making the group's revenues less sensitive to the economic cycle.
For Spirax's customers, the cost of getting it wrong can be significant. An equipment failure could result in a ruined batch of whisky, food falling below certified quality standards or a hospital being left without hot water. Against these potential financial and reputational costs, the cost of maintaining the equipment is relatively small. Around half of Spirax's revenue comes from maintenance contracts, with average invoices of around £1,500. For a plant operator, this is a modest price to pay for reducing the risk of a much more costly failure. Importantly, these recurring contracts remain highly profitable, contributing to group operating margins of more than 20%.
Regular readers may already see how Spirax fits our investment process: its low order sizes, highly reliable earnings and limited sensitivity to the economic cycle are all characteristics we value. You may therefore be wondering why we have not owned the company before. The answer is valuation. Five years ago, Spirax traded at around 48x earnings; today, the multiple is less than half that level.
We see attractive long-term growth opportunities across Spirax’s markets, supported by the continued industrialisation and modernisation of the global economy and the growing focus on energy efficiency. With a long runway for growth, strong market positioning and specialist expertise, we believe Spirax is well placed to capitalise on these trends. Combined with a strong balance sheet and a valuation that we consider more appropriate for its growth prospects, this has given us the confidence to initiate a position across our portfolios.
This article was prepared by Tom Waters, one of our Investment Managers.
