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Bodycote (LON:BOY) - a quality stock at a reasonable price

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FTSE 250 industrial heat treatment specialist Bodycote is in good financial health, reasonably valued, and is benefiting from a post-pandemic rebound in aerospace manufacturing.

Bull points

  • Rising aerospace demand as Boeing and Airbus address order backlog
  • Defence spending expected to increase from 2023
  • Stock looks reasonably valued against cyclical average earnings
  • Strong balance sheet, good cash generation
  • Track record of above-average profitability

Bear points

  • Automotive sector slowdown could hit earnings
  • Broader recession might also impact aerospace
  • Historical growth has been inconsistent
  • Exposure to faster-growing emerging markets is limited


About the Stock

Bodycote (LON:BOY) operates in the industrial sector and is part of the Machinery, Equipment amp; Components industry group.

Its shares currently trade at 535p on the LSE Main Market. Bodycote is a member of the FTSE 250 and has 191m shares in issue, giving a market cap of £1bn. Free float is 99%, so liquidity should be excellent.

The StockRanks are broadly favourable for Bodycote, with a particularly strong QualityRank. The company is classified as an Adventurous Mid Cap Neutral stock.


After a one-year share price decline of 35%, the stock is showing signs of stabilisation and an improving StockRank trend, suggesting a possible opportunity:


About the opportunity

Bodycote shares appear to offer reasonable value, with attractive growth and income qualities when compared to the broader market average:


Bodycote can be described as a quality business that’s sensitive to the business cycle. As I discussed last week, the stock’s valuation suggests that current earnings are running slightly below the 10-year cyclical average.


The opportunity here is for Bodycote to benefit from improving post-pandemic demand in the aerospace, defence and energy sectors. The main headwind to the group’s growth is a nascent slowdown in the automotive sector, another key market.

Broker forecasts suggest that profits could recover towards pre-pandemic levels over the next 18 months:


Recent trading shows supply chain issues easing and reduced levels of demand volatility. This should improve efficiency within the business, supporting margins.

Bodycote’s large-scale, specialist facilities also offer benefits to clients seeking to minimise their energy consumption and carbon footprint. As the company’s plants aggregate multiple customers’ work, they run at higher levels of utilisation than individual customers would be likely to achieve.

Bodycote believes that it can reduce carbon emissions by as much as 60% compared to customers’ DIY efforts.

A further attraction in the current energy market environment is that for some years, Bodycote has been migrating its processes from gas power to electricity. Three quarters of the company’s profits in Europe come from electrically-powered processes. This reduces the group’s carbon footprint and its exposure to the risk of gas rationing this winter.

Business amp; Model

What is the company’s history and what does it do?

Bodycote was founded by Arthur Bodycote in 1923 as a textile business. The group then went on to become part of the Slater Walker conglomerate in the 1950s. 

Bodycote was spun out of Slater Walker in 1973, after which the company began a pivot into the industrial materials sector. A series of acquisitions from 1979 onwards created a Macclesfield-based group that’s now the world’s largest provider of thermal processing services.

The company operates as a subcontractor to manufacturers. Services offered are divided into two broad categories:

  • Classical Heat Treatment: applying heat treatment to components such as engine parts and aircraft landing gear, in order to improve characteristics such as corrosion resistance and strength.
  • Specialist Technologies: a range of differentiated, higher-margin services, where Bodycote has a strong market share and sees significant growth potential. Examples include Hot Isostatic Pressing (extreme temperature/pressure treatment), surface coatings to extend component life and corrosion treatments. Bodycote also has a growing business providing HIP-treated 3D printed parts made from powdered metal.

The group operates 165 facilities in 22 countries. More than 90% of revenue is derived from outside the UK. Bodycote does not have any single customer that contributes more than 10% of revenue.

Key business segments and revenue breakdown

Bodycote generated mid-high teens operating margins over the last decade, until the disruption caused by the pandemic:


The business is divided into two operating segments. These are then further subdivided by geography. Customers in both sectors typically take a range of services from the group. The segmental split is based on customer behaviour and requirements, rather than specific service offerings.

  • Aerospace, Defence amp; Energy (ADE): customers tend to operate and purchase more globally, with long supply chains
  • Automotive amp; General Industrial (AGI): customers tend to purchase more locally and have shorter supply chains

Both segments are then subdivided geographically into Western Europe, North America and Emerging Markets.


Aerospace, Defence amp; Energy: Bodycote’s ADE business supports prime contractors in the civil and military aerospace sectors. The company’s services are typically used to improve the strength and durability of landing gear, engine parts, airframe elements and control systems.

In energy, Bodycote’s services are used in applications including wind turbines, nuclear power, and offshore oil and gas.

Customers in this division require a wide range of services, with a weighting towards higher margin specialist services. In the years prior to the pandemic, this supported segmental operating margins in excess of 20%:


Automotive amp; General Industrial: Bodycote supports major automotive OEMs and their supply chains. Services such as hardening and surface treatments are typically required to improve the strength and durability of drivetrain components, brake systems and chassis/suspension parts.

Although this division generates lower margins, this business benefits more quickly from changing market dynamics than the long-cycle ADE sectors.


What is the business model? How does it make money?

Bodycote’s business model is to provide outsourced thermal processing services for its customers. Subcontracting this work to Bodycote rather than performing it in-house offers a number of benefits for the group’s customers:

  • Access to a broader range of specialist skills
  • Economies of scale, reduced energy consumption
  • Flexible production capacity
  • Consistent, scalable service across multiple geographies.

While ADE is significantly more profitable than AGI, the profit contribution from each division has been fairly similar over the last decade:


Although Bodycote generates strong profit margins, the group appears to be able to offer an attractively-priced service to its customers. This has supported an impressive 30-year run of dividends that was only broken in 2020:


Market amp; Competition

What is the state amp; size of the company’s market?

Bodycote estimates the size of the global heat treatment market at c.£20bn annually. According to management, around 20% of heat treatment activity globally is outsourced, with the remainder performed in-house by manufacturers.

These numbers suggest that the company’s overall market share is around 3.5%, but that Bodycote has captured nearly 20% of subcontracted demand.

Who are the company’s key competitors?

Bodycote’s network is focused on North American and Western Europe, which generate around 90% of revenue. The company says it’s the largest provider of thermal processing services in both markets, with comprehensive network coverage and service offerings.

Competitors in western markets include European firms Listemann AG and Franke Industries. Although there are some other larger sub-contractors, much of Bodycote’s competition in these markets comes from manufacturers performing work in-house and from much smaller ‘mom and pop shop’ companies, operating in one region or market sector.

In emerging markets, Bodycote claims to be the leading thermal processing provider in Eastern Europe and the leading western provider in China. However, revenue from emerging markets accounts for less than 10% of the group’s revenue, suggesting its share of these important industrial markets is still limited.

What is the company’s strategy?

Bodycote’s strategy is to reduce its environmental impact while investing in quality growth:

Improving the overall quality of the business and focusing investment to drive long-term profitable growth.

Management plan to achieve these goals by investing in emerging markets and higher-margin specialist technologies. These markets offer greater volume growth potential and profitability.

Targeted acquisitions may be considered to support these aims.

Specific plans are in place to evolve the group’s offering to profit from structural trends:

Growing our Classical Heat Treatment business focused on electric vehicles and narrow-body aerospace platforms.

How does it derive its competitive advantage?

Bodycote’s business model incorporates a number of elements that might help to support an economic moat. These may help to provide a lasting competitive advantage:

  • Intangible assets: Bodycote offers a number of specialist services where it has branded offerings and market-leading technology
  • Switching costs: the group’s operations are integrated with the supply chains of many of its customers, some of whom are global manufacturers. Switching to alternative heat treatment suppliers could cause significant disruption.
  • Network effects: Bodycote’s scale and global reach is superior to most of its rivals. The company’s ability to provide a known and consistent service across multiple regions is an attraction for multinational customers.
  • Cost advantages amp; scale: by operating at scale with a specialist focus, the company is able to maintain a high level of utilisation in its plants. This helps to cut costs and reduce energy consumption per unit processed. Bodycote’s comprehensive network also enables the company to provide cost and time-effective local services where needed.

Is the competitive advantage durable?

Bodycote has achieved a long-term average return on capital of around 12% and consistently generates double-digit operating margins.

These figures would seem to suggest that the company’s competitive advantages are moderately durable, although not immune to competition and cyclical risks.

Financials amp; Ownership

What is the record of growth amp; profitability?

Prior to the pandemic, Bodycote was delivering encouraging growth at improving margins.



Free cash flow has remained solid throughout this difficult period:


What is the state of the balance sheet?

The balance sheet looks strong, with very little risk of financial distress:


Bodycote’s latest accounts showed modest net debt of £57.5m, representing less than one times forecast profit for the current year.

Although the current ratio of 0.8 seems low, it’s consistent with historic norms and appears to reflect the group’s low working capital requirements. Bodycote has historically reported negative working capital in a number of years, suggesting that it’s sometimes able to receive payment from customers before it needs to pay its own suppliers.

The company does not appear to have any onerous pension schemes. Final salary obligations were reported to be just £24m at the end of 2021. Although the scheme does carry a £14m deficit (H1 2022), this does not seem a serious concern.

Is there evidence of historic share dilution?

Bodycote has not issued a significant number of shares since 2004. The company navigated both the 2008 financial crisis and the pandemic without needing to raise fresh equity.


What is the ownership structure of the company? Do management have stakes?

Bodycote is owned by institutional shareholders. Among the more interesting names on the major shareholders list is Edinburgh-based asset manager Baillie Gifford, best known for its long-term focus and FTSE 100-listed Scottish Mortgage Investment Trust (LON:SMT) fund.

The group is run by hired managers who do not appear to have significant shareholdings.


How does the relative valuation compare versus industry and sector?

Bodycote looks reasonably valued against FTSE 250 peers Morgan Advanced Materials (LON:MGAM) and Vesuvius (LON:VSVS) – although neither is an exact match, there is some overlap between these businesses in terms of customer base and industry exposure.


Vesuvius looks cheaper, but earnings are expected to fall this year. Bodycote’s forward P/E does not seem unreasonably expensive to me, given the group’s profitability and expected earnings growth.

Taking a broader view, the shares seem reasonably valued against industry peers, according to Stockopedia data:


Trends amp; Catalysts

Are there any significant macro trends that the business is benefiting from?

Aerospace: Boeing and Airbus both have large backlogs of aircraft orders and are reported to be increasing new plane production. According to Bodycote, Airbus plans to ship more aircraft in 2022 than in 2019.

Defence: Bodycote expects defence revenues to increase in 2023 as a result of the Russian invasion of Ukraine.

Energy efficiency amp; net zero: The company’s plants are often able to provide services with a smaller carbon footprint and lower energy requirements than manufacturers’ in-house treatment facilities.

These qualities could lead to an expanded market opportunity for Bodycote, as more manufacturers consider outsourcing their thermal processing requirements.

Are there any catalysts that could drive a rerating in the medium term?

If Bodycote can return its profit margins to pre-pandemic levels and deliver renewed growth, I think a rerating is possible.

The company’s growing emphasis on specialist services and new growth markets such as EV manufacturing is another potential source of differentiation and rerating.

Risks, Threats amp; Hurdles

There’s no escaping the cyclical exposure of this business. There are already signs of weakness in the automotive sector, compounded by supply chain problems and Covid-related disruption in China.

A recession in the US could feed through to the civil aerospace sector too, dampening growth.

More broadly, the company’s Western Europe and North American markets may already be fairly mature. Expansion in China is likely to face tough competition from domestic rivals and political headwinds.

Recent Trading amp; News

Summarise recent trading statements and comment on them

Half-year results – 29 July 2022

The Group performed well in the first half. Revenues were up 14.6%, benefiting from price increases and energy surcharges which we have successfully passed on to our customers in response to the cost inflation we have experienced.

Bodycote said that Civil Aerospace revenue rose by 30% during the period, with Emerging Markets up 22% and General Industrial revenue up 19%.

The only outlier was Automotive, where revenue fell by 4%. However, management reported a reduction in demand volatility, as supply chain problems started to ease. 

The overall outlook was unchanged and positive.

While there are obvious geopolitical uncertainties, as matters stand today, we see the prospect of volume growth in each of our key market sectors and geographies and we anticipate making progress in the second half.

What do the brokers currently think and are they upgrading estimates?

The broker consensus view is broadly positive. Earnings estimates appear to have stabilised, after falling during the first half of the year. 


Drilling down into the analyst coverage reveals a mix of views on this stock. I would guess this reflects different brokers’ macroeconomic outlooks.


What would the person selling to us be thinking and who are they?

Bodycote’s half-year performance was positive and showed rising profits and margins. The stock’s valuation also seems reasonable to me.

Given this, it seems logical to suggest that the main reason to sell right now would be due to fears that the economic outlook is set to worsen significantly, reducing demand from Bodycote’s core customer sectors.


Bodycote is in good financial health and is benefiting from a post-pandemic rebound in aerospace manufacturing. Rising defence spending is also expected to provide a tailwind.

The group has been able to mitigate cost inflation and benefits from its position as one of the more energy-efficient operators in the thermal processing sub-sector.

While a deeper economic slowdown could cause results to fall below expectations, there’s no sign of this so far.

My view is that the current valuation does not reflect the current outlook for the business, offering an opportunity for re-rating.



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