Morningstar | Maintaining Weir FVE After Reviewing 2H Results
We are maintaining our fair value estimate of GBX 1,700 for Weir after reviewing the company's second-half 2018 results. The company's results in the minerals segment and newly acquired Esco have continued to improve, even as oil and gas results remain affected by the slowdown in U.S. shale completions. Our no-moat rating remains in place.Second-half 2018 revenue increased 5% sequentially on an organic basis (excluding results from Esco following its midyear acquisition), with 15% growth in minerals offsetting a 10% fall in oil and gas segment revenue. Likewise, adjusted operating margins in minerals strengthened to 18% from 17.7% in the first half, whereas oil and gas margins fell precipitously to 8.1% from 16%.
We expect the oil and gas weakness to be temporary, as an alleviation of pipeline constraints in the Permian Basin in the second half of 2019 should lead to a large rebound in the number of U.S. horizontal completions, thus causing increased equipment expenditures by Weir's pressure pumping customers. The more important question for the oil and gas segment is Weir's long-term competitive positioning. Segment revenue was down 7% year over year in U.S. dollar terms, whereas peer Gardner Denver's upstream energy revenue was up about 4% over the same period. Still, we think we've amply accounted for competitive pressures in our current valuation. Our long-term margin expectation for the segment is 17.5%, well below management's 20% long-term target (and the segment's 2010-14 average of 24%).
The minerals segment has continued to benefit from a modest increase in mining maintenance capital expenditures as well as, encouragingly, market share gains. Meanwhile, newly acquired Esco outperformed expectations in 2018. Including results before the acquisition, the new segment's revenue increased 11% from 2017, and adjusted operating margins increased to 12.2% from 10.8%, partly due to the speedy accomplishments of synergies after the merger. Altogether, synergies reached $15 million by year-end 2018, well ahead of schedule (management had targeted $30 million within three years). We believe the acquisition has added modest value to Weir (we model a value in excess of purchase price of about GBP 0.30 per share).
The Weir Group is an engineering business. Co. is organized into three operating divisions: Minerals, which provides mill circuit technology and services as well as slurry handling equipment and associated aftermarket support for abrasive high wear applications; Oil & Gas, which provides pressure pumping and pressure control equipment and aftermarket spares and services, as well as equipment repairs, upgrades, certification and asset management, and field services; and Flow Control, which designs and manufactures valves and pumps, and also provides specialist support services to the global power generation, industrial, oil and gas and other aftermarket-orientated process industries.
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