Performing stateside

Last year was a challenging one for Porvair (PRV). In the main, it marked a period of consolidation for the specialist filtration and environmental technology group, during which it has successfully navigated a period of rising cost pressure, high research and development (R&D) investment and a weak US dollar. Looking ahead, the company is entering into a new phase in which several key growth projects are set to mature on the commercial stage and become significant top line contributors.

"Relatively flat sales of £26.2 million, was in our view resilient as major gasification contracts were in place for deliveries in 2006 and 2008 but not in 2007."

But back to the year that was, last month's results (for the year to November) revealed robust performance in particular areas of the group. Despite a modest decline in total sales from £46.2 to £45.5 million, Porvair's pre-tax profits rose to £3.4, a 10 percent increase when compared to 2006.

A major contributing factor was strong growth in sales to the aviation industry. Indeed, sales in the aviation filtration division grew by an impressive 13 percent. Aviation filtration continues to be a prominent feature of Porvair's Microfiltration division which has been making significant progress since 2002.

Members will recall repeated customer delays had proven a major obstacle to supplying new filters for fuel tank inerting systems to Boeing and Airbus. Production did finally begin towards the end of last year, resulting in the start of long awaited sales.

In October last year, Porvair signed a lease on 65,000 square feet of modern factory and office space in Fareham, Hampshire. Driven by recent capacity constraints as well as increasing number of deliveries of the fuel tank inerting filters for Boeing aircraft, we see this as strong vote of confidence by management in the division.

However, performance across the rest of the UK based Microfiltration division has lagged somewhat.

Relatively flat sales of £26.2 million, was in our view resilient as major gasification contracts were in place for deliveries in 2006 and 2008 but not in 2007. After taking into account the weakness in the US dollar, operating profits were off by £1.1 million but in line with management expectations at £4.4 million.

The decline here highlights the acute inflationary cost pressures burdening manufacturers. Having increased steadily throughout 2007, factory-gate inflation in the UK reached a 16-year high last month.

However, going forward we see gasification filters and bioscience filters providing revenue more than capable of offsetting increasing costs. Indeed, Porvair completed a large commercial order with SG solutions for gasification filters with a long term estimated value of US $20 million.

In our opinion, demand for engineering and design work in this segment will pick up in 2008 where it left off, underpinning future earnings. Furthermore, a strong order book has ensured a positive start to the year.

In America, management are looking for another solid performance from that country's Metals Filtration division.

In fact, last year's turnover of US$38.6 million was a record for the business. In an example of how diversification can be beneficial, the unit benefited from the same weakness that had hindered UK operations.

During a year of restructuring, the Metals Filtration and Advanced Materials divisions were combined. The objective according to Porvair was to shift the focus away from product development and towards product commercialisation. Whilst development efforts will no doubt continue, we support this decision to pursue revenue growth.

A new 'Special Projects' unit now runs alongside the existing US-based Selee Corporation as the company aims to turn cash drains into revenue generators.

Meanwhile, Selee's product lines all weighed in with respectable performances, contributing US$37.4 million of the division's total revenue. More encouragingly, operating profits increased significantly to US$2.3 million (2006: US$0.6 million).

Earnings here were underpinned by strong sales of domestic foundry filters, exports of aluminium cast shop filters, carbon bipolar plates and metallic combustion plates. In addition, Ceramics, the operation that makes specialist metals handling products, posted another year of record sales.

Selee's revenue represents 97 percent of the Metals Filtration total. However, developments within Special Projects suggest a more telling a contribution in 2008.

"Indeed, Porvair completed a large commercial order with SG solutions for gasification filters with a long term estimated value of US$20 million."

A core customer of Selee signed a multi-year supply contract for specialist molten Nickel-Cobalt filters, and sales increased throughout 2007 as production capacity was commissioned. Once full production capacity is reached during 2008, Porvair expect this product line to contribute up to US$5 million in annual sales revenue.

Recognising that investment in R&D still remains central to the group's success, trials of the first new aluminium filter to be introduced in 25 years are also underway.

The company has decided to wait and gauge market developments before committing further investment to the next generation product in bipolar plates. The company also report that the demand for diesel emission substrates remains strong, albeit still for product development samples.

On the balance sheet, a healthy cash position of £2.9 million provides the platform on which to maintain product innovations. Solid operations have also seen cash flow from operations more than double to £5.7 million whilst net debt has declined to £7.0 million. This leaves gearing at a manageable 20 percent and interest cover a healthy 8 times.

A look at the charts however reveals that investor support for Porvair has eased over the past 12 months. Since reaching a high of 152p in February 2007, the company's share price has gradually drifted lower, touching a low of 103.5p in January.

At this stage, we cannot rule out a deeper correction in the coming weeks. However, with firm support located at 92.5p, we believe that additional downside risks are limited.

As the weekly chart displays, prices have been contained to a large base pattern over the past five years. An eventual break above here will in our view confirm the revival of longer-term upward momentum.

From a valuation perspective, Porvair trades on a prospective price earnings multiple of 15 times with a dividend yield of 2.6 percent. In our view, the positive long term earnings outlook more than justifies this valuation.

As such, Porvair will remain held within the Fat Prophets Portfolio.