Smiths Specialty Engineering
Divisional developments and performance
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Smiths Specialty Engineering |
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Description |
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Employees |
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Principal operating regions Interconnect is a global business with manufacturing in the US, the UK, France, Germany, Italy, Costa Rica, Mexico and China. Flex-Tek conducts a majority of business in the US, but also in the UK, France, Malaysia and Mexico. |
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Contribution to 2007 Group sales |
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Key customers Interconnect sells to aircraft manufacturers, defence and wireless telecoms companies. Flex-Tek serves mainly domestic appliance manufacturers and the US construction industry. |
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Business developments
In response to increasing customer demand, John Crane has been adding production capacity and locating manufacturing closer to its customers. Some of these facilities have been located in low-cost manufacturing locations, particularly in India and China. Locating in these countries has generated incremental sales from local customers.
In March 2007 Smiths purchased CDI Energy Services and Global Energy Products for US$38m. These two closely linked US-based businesses supply artificial lift systems and maintenance services to the oil and gas industry. They complement the John Crane Performance Plus logistics management programme and expand our presence in the growing upstream segment.
In August 2006 John Crane’s bearing lubrication business in Finland was sold for £15m. On 31 July 2007 Smiths finalised the disposal of its automotive seals manufacturing businesses to Cyclam Holdings LLC for a contingent consideration of £3m.
Within Interconnect, Times Microwave Systems Inc. was sold as part of the Aerospace transaction. This will not affect the performance of the remaining Interconnect business because it was a discrete business unit.
At the year end the Marine Systems which represents less than 6% of total divisional sales was being actively marketed for sale and the assets and liabilities of that business are disclosed as ‘held for sale’ on the balance sheet.
Markets
Smiths Specialty Engineering’s principal businesses – John Crane, Interconnect and Flex-Tek – each address distinct markets. High capital spending on energy production and communications networks is expected to deliver average annual growth of 7% in these markets.
John Crane is experiencing strong demand for its products and services, particularly in the oil, gas and petrochemical sector, which is its largest market. At this stage in the capital investment cycle, the growth is in the sale of original equipment for new production facilities. This will provide aftermarket opportunities in the future which are expected to generate attractive margins. Global capital spending in the energy sector is projected to continue growing in the long term in response to increasing energy consumption. The acquisition of CDI Energy Services enhances John Crane’s presence in all aspects of oil and gas production – upstream and downstream. For example, liquefied natural gas (LNG) produced in Qatar and ultimately drawn from the UK gas grid by consumers will have passed through John Crane seals and other technology at every point in its journey.
The largest markets for Interconnect are aerospace, defence and wireless telecommunications. Interconnect provides technology for un-manned aerial vehicles, next generation ground vehicles, communications systems, surveillance systems and self-protection systems. The aerospace and defence product range includes antenna systems, connectors and frequency sources. A good example of this includes five new component design contracts that Interconnect has won on Raytheon Company’s surveillance radar programme which will be deployed in Taiwan. Another is the work that Interconnect business TRAK has subcontracted from Northrop Grumman and Lockheed Martin for the Advanced Hawkeye naval surveillance aircraft. These typify areas of spending that are expected to grow despite an overall long-term outlook of declining military budgets.
In the wireless telecommunications sector, Interconnect supplies devices to protect base stations from power surges and niche microwave components. The wireless infrastructure sector is growing strongly, driven by the demand for increased capacity on the existing networks and for new infrastructure in Asia. In China, Interconnect business Transtector is providing key components (including surge protection) for the TD-SCDMA wireless base station antennas, helping to achieve a high-level and reliable performance for mobile phone customers. Growth in this area is expected to continue as subscriber numbers increase and subscribers demand greater coverage, better connectivity and increased functionality.
Other applications for Interconnect products include medical equipment such as MRI scanners and railway signalling systems, both of which are seeing good growth at present.
Flex-Tek supplies engineered flow and heat technology equipment for construction, consumer products and aerospace applications. Its products include proprietary hose and tubing technology, natural gas delivery systems, rigid tubing assemblies in high ferrous metals and open coil convection heating. The main customers are domestic appliance manufacturers and the US construction industry. Demand is normally a function of overall economic growth and the strength of the US construction industry.
Flex-Tek is strong in customer-focused product development. For example it has developed an air duct called ‘Thermaflex’ which has obtained certification for use in applications where children are present, including day care centres – the first company to have obtained this certification. The product reduces the amount of chlorofluorocarbons and other hazardous materials that are expelled into the atmosphere and is being used extensively in the US.
Performance
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2007 |
2006 |
Movement |
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Sales |
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John Crane |
532 |
518 |
3% |
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Specialty – Other |
500 |
513 |
(3)% |
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1,032 |
1,031 |
1% |
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Headline operating profit |
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John Crane |
75 |
66 |
13% |
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Specialty – Other |
66 |
71 |
(6)% |
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141 |
137 |
3% |
Sales
Sales rose by 1%, driven by the sales growth at John Crane and Interconnect. Adverse movements in exchange rates have reduced John Crane sales 5% and Specialty – Other sales by 6%. Excluding acquisitions, disposals and the effect of exchange translation, John Crane sales rose by 9% and Specialty – Other sales by 3%.
In oil and gas John Crane had a 25% increase in its supply of seals to Original Equipment Manufacturers, well in line with the positive market trend. Projects contributing to this growth were:
- new ethylene cracker plants in China;
- gas extraction and processing in the UAE; and
- ethane cracker and petrochemical plants in Saudi Arabia.
The performance of Specialty – Other has been mixed. Interconnect had a very good year with double digit sales growth after adjusting for acquisitions, disposals and the effect of exchange transactions. Flex-Tek suffered from a reduction in demand for products serving the US domestic construction industry. Marine’s financial performance was similar to the previous year.
Interconnect benefited from increased military spending on network-centric systems to provide effective battlefield communications. Interconnect provides a range of microwave components which are developed specifically for each project. Smiths equipment is vital to the operation of the Eurofighter Typhoon, for example, generating healthy sales in this period.
Headline operating profit
Headline operating profit rose by 3%, with growth of 13% at John Crane off set by a 6% decline at Specialty – Other. The translation of the overseas results at weaker exchange rates reduced the division’s profit by 7%.
The benefit of volume, together with cost savings, generated strong profit growth at John Crane. Excluding acquisitions, disposals and the effect of exchange translation, headline operating profit for John Crane increased by 22%. Margins rose to 14.1%.
Raw materials prices, particularly for stainless steel, nickel and copper, have been rising. However, strong demand enabled John Crane to pass on commodity price increases.
Excluding acquisitions, disposals and the effect of exchange translation, headline operating profit for Specialty – Other reduced by 1%. Reflecting the mixed sales performance, Interconnect had double digit headline operating profit growth on this basis while Flex Tek suffered from demand being significantly down. In addition, Flex-Tek had to absorb commodity cost increases.
Higher raw materials prices also adversely affected working capital management for Specialty Engineering as a whole, leading to higher carrying values for inventory.
On a statutory basis, operating profit was £1m for John Crane (2006: £71m) and £61m for Specialty - Other (2006: £63m).
Research and development
R&D expenditure for the division is £21m, £3m lower than previous years. This decline partly reflects weaker US dollar exchange rates in the period. R&D expenditure is 2% of revenue.
Forward-looking issues
Smiths strategy is to grow each of the principal Specialty Engineering businesses. In pursuit of this strategy, Smiths aims to broaden the customer or market base where the application of its technological expertise and engineering skills are most appropriate, for example the development of Interconnect products for the medical equipment market.
Smiths Specialty Engineering’s outlook is for further growth in the year ahead, helped by the continued upturn in the investment cycles for oil & gas and telecoms infrastructure.