1. UK Manufacturing Industry Landscape

The Manufacturing industry plays a pivotal role in the growth of any economy. Moreover, the manufacturing industry includes chemicals, textiles, machines, industrial engineering, and equipment. The manufacturing sector processes raw materials into finished goods and produces them in large quantities. Furthermore, it modernizes agriculture, and enhance productivity & provide employment opportunities in the secondary & tertiary sectors.

According to recently available data from IHS Markit/CIPS, the UK manufacturing PMI had reached near-record levels during April 2021 despite several supply chain headwinds caused by the Covid-19 pandemic. The manufacturing Purchasing Managers’ Index came out to be around 60.9 during April 2021 as compared to 58.9 reported during March 2021. Furthermore, the PMI figure increased for eleven consecutive months, and the latest reading remained the highest since 1994. There are several factors which have strongly contributed towards the growth are loosening of lockdown restrictions, improving demands and a rise in backlogged work.

Furthermore, with reference to the recent data available from Britain's Office for National Statistics (“ONS”), the UK monthly production went up by around 1.0% in February 2021 as compared to the prior month. However, the production remained 3.5% lower on a year-on-year basis. Moreover, the production output remained around 3.3% lower for the three months to February 2021 when compared with an equivalent period of the prior year. On the productivity front, British workers' average hourly output had increased by 0.4% during FY20, even after a drop of approximately 10% in total production due to the Covid-19 pandemic.

Key Trends in the Manufacturing Sector

• Artificial Intelligence – The incorporation of artificial intelligence can enhance the manufacturing quality and further accelerate the supply chain process.
• Advanced Robotics – The entire industry is adapting to more advanced robotics to neutralise the adverse impact of reduced access to labour and skills.
• Internet of Things (IoT) – It facilitates manufacturers to connect and monitor the progress of the operations, developing possible insights.
• Enterprise Resource Planning - ERP systems help manufacturers to automate a different range of operations under one comprehensive system.

Risk Exposures to the Manufacturing Sector

• Environmental Impact – The failure to adopt or apply ethical standards and environmental compliance can contribute to climate change. The manufacturing industry is already one of the most regulated industries, and the regulatory environment is becoming more complex.
• Health & Safety – The sector uses and manufactures hazardous chemicals, and any mishandling, leakage or accident can lead to injury or death at the manufacturing plant. There needs to be a proper supply chain integration, and stringent safety measures need to be put in place to prevent incidents.
• Government Regulations – Changes in regulations in the manufacturing industry can affect the business environment. The regulatory norms drafted by the government keeps on changing, and thus, it is important to work in line with the regulations set by the government.

SWOT Analysis

Benchmark Index Performance

Based on the last one-year performance, the FTSE All-Share Industrial Engineering index has outperformed the FTSE 100 index, FTSE 250 index, and FTSE All Share index. Furthermore, the FTSE All-Share Industrial Engineering index generated a return of about 48.01%; however, the FTSE 100 generated a return of around 16.98%, FTSE 250 produced a return of around 36.23% and the FTSE All Share index generated a return of about 21.07%.

Figure 1: One Year Benchmark Index Performance

 (Source: Refinitiv, chart created by Kalkine Group)

Manufacturing Sector Outlook

According to the IHS Markit, around two-third of companies had forecasted higher output in 2021 as compared to 2020, benefitted by several factors such as expectations for less disruption related to COVID-19 and Brexit, accelerated economic recovery, improved client confidence and new product launches. Furthermore, the relaxation of Covid-19 restrictions would lead to another marked growth spurt at UK factories. The manufacturing PMI rose to a nearly 27-year high, driven by accelerated output and a robust order book. Meanwhile, the export growth remains relatively subdued, however, as small manufacturers struggle to export. Overall, the manufacturing sector would be expected to perform well during 2021, with growth more weighted towards the second half of 2021.

2. Investment analysis and stocks under discussion (SMIN, HILS, MRO)

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

A. Smiths Group PLC (LON: SMIN)

(Recommendation: Buy, Potential Upside: 20.12%, Market Capitalization: GBP 6.08 billion)

Smiths Group PLC is an FTSE-100 listed multinational technology company engaged in manufacturing and selling of control systems and instrumentation for industrial applications to customers based in over 200 countries and territories around the world.

Valuation Methodology

Our illustrative valuation model suggests that the stock has an upside potential of 20.12% over the closing price of GBX 1,535.00 (as of 11 May 2021).

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

(Recommendation: Buy, Potential Upside: 20.84%, Market Capitalization: GBP 1.22 billion)

Hill & Smith Holdings PLC (LON: HILS) is an industrial engineering company supplying and manufacturing of galvanizing services and infrastructure products. It is listed on the FTSE 250 index.

Valuation Methodology

Our illustrative valuation model suggests that the stock has an upside potential of 20.84% over the closing price of GBX 1,534.00 (as on 11 May 2021).

C. Melrose Industries PLC (LON: MRO)

(Recommendation: Hold, Potential Upside: 11.62%, Market Capitalization: GBP 7.58 billion)

Melrose Industries PLC is the FTSE 100 listed Company, which owns manufacturing and industrial business with a leading market position operating across several geographies. The Company's reportable business segments are Aerospace, Automotive, Power Metallurgy, Nortek Air Management, and other industrial division.

Valuation Methodology

Our illustrative valuation model suggests that the stock has an upside potential of 11.62% over the closing price of GBX 156.00 (as on 11 May 2021).

*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 12 May 2021.

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