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Morningstar | Johnson Matthey’s Clean-Air Segment Grows in 1Q Despite Declining Auto Production

After reviewing narrow-moat Johnson Matthey’s first-quarter trading update, we are maintaining our GBX 3,200 fair value estimate. First-quarter sales were flat in constant currency compared with the prior-year period because robust growth in the clean-air segment was offset by lower sales in efficient natural resources and health. The company maintained fiscal 2020 guidance for operating performance to be within medium-term targets for mid- to high-single-digit growth, although the parts have moved around slightly. Clean air is now expected to be down slightly over 2019 while expectations for efficient natural resources have improved. At current levels, the shares look fairly valued.

Clean-air sales grew strongly in the first quarter because of market share gains in European light duty, which offset a 6% decline in regional production. The rest of the segment was broadly flat. Fiscal 2020 operating profit is now expected to be down slightly because of higher-than-expected short-term costs to complete the new plant in Poland and the delay in implementing China IV legislation. The growth outlook remains positive for the next few years given globally tightening legislation. In the long term we expect profits to decline primarily because of falling market share, the shift from diesel to gas in European light-duty vehicles, and increasing penetration of electric vehicles in Europe and Asia.

Sales were down moderately in efficient natural resources because of a tough comparable in methanol catalysts. On the positive side, platinum group metals   services are growing well and the outlook for the second half of the year has improved. In the medium term, we expect operating profits to grow at a low-single-digit rate, reflecting market growth and some improvement in margins from operational excellence.

Health sales were down due to lower sales of generic APIs, as expected. However, the company continues to expect stable sales and double-digit operating profit growth in fiscal 2020, although more weighted to the second half of the year. We are optimistic that profits will begin growing quickly during the next few years given the company’s strong pipeline of generic APIs, which should significantly boost sales and margins.