The Investment Column: Smiths profits from free cash

SIR ROGER HURN's track record at Smiths Industries is second to none. Under his stewardship, the engineering group has prospered in industries that are far from sexy: aerospace, medical systems and industrial products. As Sir Roger turns his attention to the chairmanship of GEC, however, the question is whether Smiths can keep it going.

Interim results for the six months to 31 January, released yesterday, showed no obvious weak points. Despite a squeeze from sterling, Smiths produced a solid 11 per cent increase in pre-tax profits to pounds 89.3m. That rise includes a contribution from Graseby, the medical pumps business that Smiths bought last year for pounds 136m. But the aerospace and industrial divisions also produced good organic growth. Only the medical side, which suffered from the strong pound, lagged behind with a 3 per cent underlying rise.

Can this last? Well, maybe. The key to Smiths' success is its huge free cash flow, which it can use to finance investment and acquisitions. Even after paying for interest, tax, dividends and capital spending, Smiths generated almost pounds 34m of cash in the half year.

A few clouds have appeared on the long-term horizon, however. The first is the civil aerospace cycle, which is likely to head down again in a few years' time. Smiths says demand for defence aerospace will more than make up the shortfall, but analysts wonder what will happen to margins. Another question is how long Smiths can carry on its three-pronged growth strategy before the divisions become too cumbersome and suitable acquisitions too hard to find. Smiths' role in the restructuring of the European defence industry is another imponderable.

On full-year profit forecasts of pounds 220m, the shares, up 2.5p to 874p, trade on a forward p/e ratio of 18, suggesting the market thinks Keith Butler-Wheelhouse, Sir Roger's successor, will produce more of the same. He deserves the benefit of the doubt, but only just. For now, high enough.