Has this FTSE 100 favourite hit its pinnacle?

Spirax Sarco Engineering (LSE:SPX) is a venerable company (130 years-old) with a fascinating history. So interesting in fact, it has an entire book written about it (Knowledge, Service, Products: The History of Spirax-Sarco Engineering by Nigel Watson). 

It was first quoted on the London Stock Exchange in 1959 and now employs over 7,500 people worldwide, serves over 100,000 direct-buying customers, and has over 1,500 core product lines. It reached another significant milestone when it was promoted to the FTSE 100 on Christmas Eve 2018. Since then, the share price has steadily climbed, peaking at £94 in early July and its year-end report has pleased existing shareholders. However, I’m not sure the company is set up to sustain this recent success, so let’s take a look.

Financial overview

With a trailing 12-month price-to-earnings ratio (P/E) of 29, this is much higher than the average of 17.9 for this industry. Nevertheless, its average P/E over the past five years has been just under 25, which is not significantly lower so maybe it could still climb?

But there are other metrics that suggest it might not. Spirax Sarco’s debt ratio is 51% which is greater than the recommended peak of 40%, and its level of debt has increased from 25% over the past five years. That said, operating cash flow more than covers the total debt and interest payments on debt are covered by earnings.

As the debt has increased, so has the share price, so the company has been doing something right. It saw an outstanding increase of 41% in EPS in the last year but this was due to acquisitions and panic-buying customers worried about Brexit, as well as strong organic sales growth of over 7%. 

Spirax Sarco has a pretty poor dividend yield of 1.1% but it has remained stable and consistent over the past 50 years.

Opportunities ahead

The company argues that it still has immense opportunities ahead for growth, holding only a 14% share of the world markets (worth £8.5bn) it is involved in.

The success of recent expansion into emerging markets, in countries such as Myanmar, Peru and Indonesia, remains to be seen. Although emerging markets can offer untapped opportunities and riches, they can also be risky, especially given the fragility of the world stage today.

Gaining new businesses and technologies is usually a positive action, but could this have stretched the group’s finances a step too far? This business is not averse to cyclical pressures and current margins offer limited expansion potential.

The company prides itself on its direct selling approach and this, along with strong relationships, long-term vision and employee appreciation, contributes to the strength of the business and backs up its resilience to economic disruption. In theory, it should be well-positioned to grow and develop into the future. However, analysts have been backing off lately, with a general feeling that the share is now overvalued and its price is too high.

Given that this engineering firm has done so well recently but has nothing outstanding in the pipeline to continue this rise, along with its pathetic dividend offering, I’m inclined to avoid it for now. I also worry it could be ready to take a big tumble if a recession rears its ugly head.