1. UK Manufacturing Sector Market Landscape

Technology, speed and innovation are driving the growth of the manufacturing sector. The manufacturing sector is on its toes to adapt the complex technology and address the changing customer needs and demand. The manufacturing sector is an important part of economic growth as it accounts for a significant portion of the global GDP. The US and China are the leaders in the global manufacturing sector. The global manufacturing sector is expected to witness a decline in 2020. As per the Interact, the global manufacturing output will fall by 7.6% in 2020, and most countries are expected to reach the 2019 level of production by 2024.

The UK's manufacturing industry makes up close to 11% of the gross value added (GVA). The manufacturing sector makes up 44% of the total UK exports and 70% of business research & development. The manufacturing sector in the UK employs close to 2.6 million people. As per the Manufacturer's Organisation UK, the manufacturing industry is expected to decline by 10% in 2020. The industry slipped down by 1.5% in 2019. However; the manufacturing sector is expected to witness a growth of 5.8% in 2021.

The manufacturing sector in the UK is likely to get a boost from various government initiatives. The UK government has launched a road investment strategy for 2020 to 2025 with a budget of £27.4 billion.

The production in the UK in September 2020 was 5.6% below the February 2020 level. The production increased by 0.5% month on month in September 2020. The manufacturing subsector within the production section grew by around 0.2% month on month in September 2020. However, the manufacturing output was approximately 8.1% down from the pre-pandemic level in February. As per the Office for National Statistics data, the government agency categorizes the manufacturing under 13 subsectors, with machinery and equipment manufacturing being one of them, and it grew by 0.08% in September 2020.

Industry 4.0

Industry 4.0 builds on the fourth industrial revolution that includes the adoption of computers and automation that is supported by smart autonomous systems driven by data and machine learning. The key challenge for the Industrial 4.0 era is to balance the demand for productivity and with the requirement for a skilled workforce capable of delivering it. Transformation of the sector with the use of disruptive technologies such as IoT, analytics and artificial intelligence can help the businesses to boost revenue. There are few technologies that are trending in the manufacturing sector in the UK, which includes nanotechnology, bioinformatics, quantum technology, blockchain, augmented reality, cybersecurity, cloud computing and additive manufacturing.

Key Trends in the Manufacturing Sector

• Artificial Intelligence - Artificial intelligence in collaboration with other leading technology will help in manufacturing and supply chain. It is already being used in the manufacturing sector, but its application and use will become more popular with time, and it would help in achieving efficiency, greater precision and cost-cutting.
• Advanced Robotics - This has helped in automation, and it is paving the way for future success. The manufacturing sector is adapting to more advanced robotics to mitigate the impact of reduced access to labour and skills. It will also help in producing the best-designed products at competitive prices.
• 3D Printing - The demand for 3D printing has surged with a demand for sustainable solutions and customized solutions. It is the process that produces objects in accordance with a 3D digital model. It adds material layer by layer and manufactures complex objects both rapidly and at low cost. The functionality of 3D printing provides speed, quality and strength.
• Augmented Reality - It can perform the quality check of the products manufactured. A piece of product that is required to be manufactured can be envisioned, and a variety of changes can be identified beforehand. Training for the usage of large and complex machinery can be provided using AR technology. It can also be used for preventing errors, reducing production downtime, and it can also cut downtime on maintenance.

Risk Exposures to the Manufacturing Sector

• A Cutback in Investment - The manufacturing sector is a capital intensive sector, and it requires a large amount of investment to carry out research & development as well as production. The lack of appropriate investment in the sector can affect business activity.
• Subdued Economic Activity - The sector is highly dependent on global economic growth, and a subdued economic activity can drive the demand for the manufacturing sector downwards. The challenges in a certain market can emerge as a risk. The pandemic outbreak was difficult to predict, and its impact has put some of the major economies into recession.
• Lack of Technological Innovation - Continuous innovation is an integral part of the product offering by the manufacturing sector. The failure to innovate can lead to product obsolescence. The development of a commercially viable product is essential for the sector.
• Violation of Laws & Regulations - The failure to comply with laws can result in financial and criminal liabilities. Government related contracts, restrictions on the ability to trade or rejection by financial counterparties can lead to reputational damage.
• Climate Change Risk - The manufacturing sector has a large quantity of hazardous material that impacts the environment. Any incident that can result in environmental damage may lead to significant fines, cancellation of contracts & license and injuries or fatalities.

Benchmark Index Performance

Based on the six months performance, FTSE All-Share Industrial Engineering index outperformed the FTSE-100. FTSE-250 and FTSE AIM 100 index. FTSE All-Share Industrial Engineering generated a return of (+29.63%), whereas FTSE AIM 100 index generated a return of (+20.51%). FTSE-100 and FTSE-250 generated returns of (+7.01%) and (+20.51%), respectively over the period of six months.

Fig 3: Six Months Benchmark Index Performance

(Source: Refinitiv, chart created by Kalkine Group)

SWOT Analysis

Manufacturing Sector Outlook

The pandemic has weighed down on the manufacturing sector, and it is forecasted to decline by 10% in 2020. The manufacturing orders in the UK and export orders for the UK's manufacturing sector are expected to remain low. The coronavirus has impacted the business of all manufacturers, whether they are small or big. The short-term outlook of the manufacturing sector is expected to be bleak; however, a nationwide recovery plan from the government could provide some relief. The manufacturing sector in the UK is expected to witness a growth of 5.8% in 2021. The digital transformation and productivity improvement will improve the long-term outlook of the manufacturing industry.

The declining order book and lowering production has made many investors halt the investment plan and discretionary cutback expenses.  The ongoing volatility in costs and policy decisions and the impact of covid-19 has affected the manufacturing industry. As per the Manufacturer's Organization, in Q2 2020, the orders in the UK manufacturing sector declined by around 52%, and in the Q3 2020, the orders are expected to remain at -41% on the balance of total orders. It is important for the UK to secure a favourable trade deal with the European Union to keep the export market for the manufacturing sector upbeat.

It would be important to see how the UK paves the way for its manufacturing sector after it completely separates from the European Union. The growth of the sector will be driven by new ties and partnerships. The manufacturing sector of the UK derives a significant portion of its revenue through exports, and it would be critical to watch out the government's stance for the uninterrupted continuity of the sector. In order to boost the manufacturing sector of the UK, the government has to come up with more R&D initiatives and commercialization.

2. Investment Analysis and Stocks Under Discussion (DCC, HILS, SMIN, ASY)

After gaining insights into the manufacturing sector, we would look at the business model of four manufacturing players listed on the London Stock Exchange.

A. DCC PLC (LON: DCC)

(Recommendation: Buy, Potential Upside: 21.96%, Market Capitalization: GBP 5.43 billion)

DCC PLC is a UK based company that provides international sales, marketing and support services. The Company operates the business under four business lines that include, LPG, Retail & Oil, Technology and Healthcare. DCC PLC is listed on the FTSE-100 index.

Valuation Methodology

Our illustrative valuation model suggests that the stock has the upside potential of ~21.96% over the closing price of GBX 5,558.00 (as on 24 November 2020).

B. Hill & Smith Holdings PLC (LON: HILS)

(Recommendation: Buy, Potential Upside: 18.90%, Market Capitalization: GBP 1.03 billion)

Hill & Smith Holdings PLC is a UK based company that is focused on engineered products for roads and utility markets. The Company segregates the business under Infrastructure products-Road & Security, Infrastructure Products-Utilities and Galvanizing Services. Hill & Smith Holdings is listed on the FTSE-250 index.

Valuation Methodology

Our illustrative valuation model suggests that the stock has the upside potential of ~18.90% over the closing price of GBX 1,364.00 (as on 24 November 2020).

C. Smiths Group PLC (LON: SMIN)

(Recommendation: Hold, Potential Upside: 6.70%, Market Capitalization: GBP 6.07 billion)

Smiths Group PLC is a UK based industrial technology company. The Smiths Group categorizes the business under John Crane, Smiths Detection, Flex-Tek, Smiths Interconnect and Smiths Medical. The Company is listed on the FTSE-100 index.

Valuation Methodology

Our illustrative valuation model suggests that the stock has the upside potential of ~6.70% over the closing price of GBX 1,546.00 (as on 24 November 2020).

D. Andrews Sykes Group PLC (LON: ASY)

(Recommendation: Avoid, Potential Downside: 11.83%, Market Capitalization: GBP 231.96 million)

Andrews Sykes Group PLC is a specialist company that provides pumping, heating and cooling solutions. The key brands of the Company include, Sykes Pumps and  the Andrews family of climate control solutions. The Company has 30 depots throughout the UK and Ireland. Andrews Sykes is listed on the FTSE AIM 100 index.

(Source: Refinitiv, chart created by Kalkine Group)                                                      

Valuation Methodology

Our illustrative valuation model suggests that the stock has the downside potential of ~11.83% over the closing price of GBX 550.00 (as on 24 November 2020).    

*All forecasted data and peer information have been taken from Refinitiv, Thomson Reuters.

*The "Buy” recommendation is also valid for the current price as covered in the report as on 25 November 2020.

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