Why Low & Bonar plc Could Thrash Returns From HSBC Holdings plc And Rio Tinto plc

Big cyclical firms such as HSBC Holdings (LSE: HSBA) (NYSE: HSBC.US) and Rio Tinto (LSE: RIO) (NYSE: RIO.US) strike me as both operating with commodity-style businesses.

Although large in terms of their market capitalisations, neither firm produces much added value to their product offerings. Go to HSBC for a bank account or a loan and we might as well go to any banking company; buy a ton of iron ore or copper from Rio Tinto and we could buy it from any producer (ignoring geographical limitations).

Cyclically challenged

These gargantuan firms might feel safe because of their size, but a peek at the longer-term share price charts in each case tells a story of disappointed long-term investors.

Perhaps now, with the shares down, both HSBC Holdings and Rio Tinto look attractive as cyclical bets on the next up-leg. Maybe. But I think there are better cyclical options on the stock market if we just look down the rankings to smaller market capitalisations.

Rather than going for these out-and-out cyclical monoliths with undifferentiated products, maybe it’s better to look for a firm that adds more value to the final product it produces. That’s why I’m looking closely at performance materials manufacturer Low & Bonar (LSE: LWB).

A niche operator

It’s true that Low & Bonar’s business has a large element of cyclicality, too. However, I think the firm’s strong position in a number of niche markets gives the company some insulation from the immediate effects of macro-economic cyclicality. There’s also scope for Low & Bonar to grow if its innovations and project solutions ‘click’ with customers.

The firm makes things such as carpet backing, side curtains for lorry trailers, tensioned architectural products, marquees, tarpaulins, artificial grass and soil reinforcement solutions such as grid matting and the like — but that’s not an exhaustive list.

Often Low & Bonar designs bespoke solutions for big projects and, it seems to me, keeps developing new products and innovations within its focus of operating as a performance materials firm.  

On track

This month’s half-year report showed a 0.9% uplift in revenue on a constant currency basis and the directors reckon Low & Bonar is on track to hit market expectations for the full year — City analysts following the company expect the firm to grow earnings 4% this year and a further 11% during 2016.

With an operating margin running at about 6.8% and the return on capital employed registering 11.8%, Low & Bonar rises above many other ‘me too’ operations that score lower ratings on those metrics. That suggests strength in the firm’s niche market positioning.

Low & Bonar’s financial record seems steady; perhaps the company can repeat the trick going forward:

A 69% dividend increase over four years is respectable. Meanwhile, rising revenue offers the promise of more to come.

If that dividend is to keep growing, Low & Bonar’s business has to keep expanding, too, and on that point, the firm’s record looks encouraging. With potentially benign macro-economic conditions ahead, we could see continuation of the progressive dividend policy.

Valuation now

At a share price of 69p (market cap. £225 million) FTSE Small-Cap constituent Low & Bonar trades on a forward dividend yield around 4.2%, and forecasters expect 2016 earnings to cover the payout more than twice.

Meanwhile, the forward price-to-earnings ratio sits at 11, which seems undemanding when taken with that dividend payment and the earnings growth analysts expect.

Low & Bonar’s shares remain down a bit from the levels achieved during 2014, but the weakness is nothing compared to the share-price destruction we’ve witnessed at HSBC Holdings and Rio Tinto, and could be something of a buying opportunity.