Why this stock remains JPMorgan’s top pick in the U.K. market?

Investing.com -- J.P. Morgan has reaffirmed IMI (LON:IMI) as its top pick in the U.K. market, pointing to a combination of improved performance, attractive valuation and potential catalysts that could drive further upside.

Since Roy Twite became chief executive in 2019, IMI has recorded stronger organic growth, higher margins and improved returns on capital.

Adjusted earnings per share have grown at an average annual rate of about 11% since then, with operating margins climbing to 19.7% in 2024, only 40 basis points below a peer composite J.P. Morgan calls “Synthetic IMI.” By 2027, margins are forecast to exceed 21%.

Despite this operational improvement, the shares have de-rated relative to peers. IMI currently trades at a 27% discount to the peer group on an EV/EBIT basis, compared with a 10% discount between 2014 and 2019. 

On a price-to-earnings basis, the discount has widened from 17% to 35% over the same periods. 

J.P. Morgan said this mismatch between performance and valuation highlights “the value on offer for a significantly improved business”.

The bank raised its price target to 2,850p from 2,500p, implying 27% upside from the current share price. 

A sum-of-the-parts analysis excluding the Transport division, which is under strategic review, suggests even greater upside of 34% with a fair value of 3,010p.

J.P. Morgan views a potential sale of the Transport business as the best outcome, saying it would crystalize value, support shareholder returns of about 4% of market capitalization and leave IMI with a higher-quality portfolio.

End market recoveries are also seen as a key driver of earnings balance across divisions.

Process Automation has been the main growth engine, but J.P. Morgan expects stronger contributions ahead from Climate Control, Industrial Automation and Life Sciences, where markets are showing signs of recovery. 

The brokerage noted that concerns about oil exposure in Process Automation are overstated, with only about 12.5% of the division’s revenue linked to upstream and midstream oil and gas.

Finally, stronger cash generation is expected to give IMI significant financial flexibility. Free cash flow is forecast to exceed £1 billion between 2025 and 2027.

If no acquisitions are pursued, the bank sees scope for share buybacks of around 11% of market capitalization, while acquisitions could amount to 17% of market capitalization.

Taken together, J.P. Morgan said IMI’s stronger fundamentals, relative undervaluation, potential portfolio changes and cash optionality justify its position as the firm’s top U.K. stock pick.