Engineering shares tipped to bounce back as reality bites

Share prices in the UK’s large engineering companies should recover from the battering they have suffered at the hands of internet stocks by the end of the year, a senior City analyst said this week.

Strong full-year results from engineering groups like TI, GKN and IMI were ignored this month as investors piled into high-tech stocks, which are seen as having better potential.

However, Brian O’Keefe, head of engineering research at Commerzbank, said engineering prices should pick up again around this autumn’s interim results season.

`Engineering firms traditionally have cash outflows in the first half, but we may well see some cash-positive positions this year,’ he said. `Investors would have to be blind not to see the value of record amounts of cash.’

O’Keefe said many investors had been wary of engineering companies because they had a reputation in the past for poor management and volatile results. But better management, resulting in consistent earnings, should lure them back.

The sector could also receive a boost when internet companies start to be valued on the same basis as manufacturers, distributors and retailers. The current high ratings given to companies such as internet provider Thus are based on potential future earnings rather than results.

`At the moment, the market appears to think a bird in the bush is worth 10 in the hand,’ said O’Keefe. `But as soon as these new companies start to pay profits, they will be judged by traditional methods,’ he added.

As a result, funds which had been invested in the poorer performers among the internet companies will be re-invested in the better performers among more traditional companies.

And the engineering sector is more likely to benefit than retailers and distributors. This is because, unlike service-sector companies, engineering firms’ activities cannot be replaced by internet technology.

Demand for manufactured products is unlikely to be displaced by new technology. `Cars have to be built with machinery, and aircraft will have to be built for people to use the tickets they bought on,’ said O’Keefe.

Companies tipped by Commerzbank as having particularly good prospects include BAE Systems, Invensys and IMI, the fluid systems engineer. IMI is forecast to yield a dividend of 7-8% over the next two years.

TI Group should also recover from its present low valuation if the market follows the line taken by Commerzbank. Earlier this month, chairman Sir Christopher Lewinton hinted that the firm might consider going private if its share price failed to recover.

But some industry watchers are more cautious about an engineering sector recovery this year. David Larkam, engineering sector analyst at stockbroker Albert E Sharp, said: `Engineering stocks will start to recover when sterling starts to fall and when institutions stop trying to buy into the future economy.’

Some smaller funds have started to sell e-commerce shares and invest in other sectors, he added. But the effect had so far been reduced by institutions and tracker funds, which had bought the newer firms to ensure they had balanced portfolios.

In the short term, a downgrading of engineering shares should not affect individual company performance on sales and profit levels. However, engineering employers could hit recruitment problems if potential employees cannot be attracted with the same high-growth stock options currently offered by internet companies.

And acquisitions may be more difficult as, when lending money, banks tend to look at a company’s market capitalisation – the value of its shares multiplied by the number of shares.