Despite improved security efforts, terrorism remains a constant and serious risk. Among the competitors vying for growing counter-terrorism expenditures, one company stands out for its investment fundamentals and innovative technology: Smiths Group (LONDON: SMIN, PINK: SMGZY.PK).
Smiths Group, a London-based manufacturing conglomerate, specializes in the advanced body scanners that are increasingly coveted by airports and other security-conscious organizations around the world.
The company's Smiths Detection division makes body scanners and equipment for the detection of weapons, explosives, chemical agents, biohazards, narcotics, and contraband. Smiths Detection represents roughly 19 percent of Group sales.
Threats to the flying public remain in the forefront of terrorism concerns. Frost & Sullivan reports that total global expenditures on airport security in 2011 reached $19.1 billion and will exceed $45.4 billion by 2018.
According to the Homeland Security Research Corp, the global market for body scanners alone will grow from $1.2 billion in 2011 to $1.9 billion by 2016. Demand for scanners will be especially acute in terror-troubled areas such as the Middle East and India, as well as China's rapidly expanding civil aviation sector.
Smiths Detection commands about one-third of the scanner market, making it the world leader. In addition to airports, the company also supplies scanners to hospitals, prisons and militaries around the world.
Smiths Detection is the leading maker of millimeter-wave, or "full body" scanners, which are increasingly seen by security officials as the most effective way to prevent terrorist infiltration at key checkpoints.
These scanners work by using low-level radio waves; two rotating antennae cover the passenger from head to foot with radio frequency energy. In about 40 seconds, the scan produces a negative-like image that depicts anything under a passenger's clothing, including plastic, chemical explosives and non-metallic weapons not revealed by conventional security methods.
A Boost from TSA
In May, the U.S. Transportation Security Administration (TSA) announced that it would accelerate full-body screening for as many as three in four air passengers, to mitigate criticism the agency has received for patdowns of children, seniors and members of Congress. The TSA is part of the US Department of Homeland Security (NYSEARCA:DHS).
The TSA envisions expanding enrollment in its PreCheck expedited-screening program beyond frequent flyers selected by airlines. The agency plans to require that 75 percent of the flying public use PreCheck, with the rest going through traditional, more intensive screening lanes.
DHS' budget for 2012 is $57 billion, a 3 percent increase over 2011, with $215 million earmarked for more body scanners in airports around the country.
The Obama administration has proposed deploying as many as 1,275 full body scanners in US airports. By the end of 2012, the DHS expects to add 275 scanners to the 500 already installed and operated by the TSA at 78 airports nationwide. As the clear leader in this product niche, Smiths Group is poised to reap the lion's share of these initiatives.
For the six months ended January 2012, Smiths Group reported revenue of GBP1.4 billion, a 3 percent increase over the same period last year. Earnings fell 41 percent to GBP111 million, but sales in emerging markets and the Middle East grew from about 12 percent to 15 percent of Group sales. Smiths Detection's sales during the period dropped 11 percent to GBP220 million, largely a reflection of temporary order delays.
The stock has taken a hit lately because of the company's disappointing performance, but the earnings dip was largely due to one-time charges. Investors are missing the fact that Smiths Detection is gearing up to launch a record number of new security products over the next 18 months.
Notably, Smiths Detection recently unveiled a next-generation explosives scanner for baggage that uses 3D technology to detect not just metals but also ceramics, plastics and liquids. The company also launched an advanced mobile radiation detector this year that has already received a $4.5 million order from the US military.
In March, Smiths Detection won a contract worth more than $125 million to supply all the main security scanning systems at the New Doha International Airport in Qatar, the company's biggest contract win to date and a foothold in the growing Middle Eastern market. Also in March, Smiths Detection won a $20 million contract to supply India's customs authorities with scanners.
If the world's airports follow through on their current plans to adopt full body scanners, it could boost earnings per share (NYSEARCA:EPS) at Smiths Group by up to 4 percent a year, based on a five-year roll out.
Despite these strong trends in its favor, Smiths sports a reasonable price-to-earnings ratio (P/E) of 15.6. California-based OSI Systems (NSDQ: OSIS), parent company of Smiths' direct competitor Rapsican, has a P/E of 27.
Smiths other major competitor in the scanner market is L-3 Communications Holdings (NYSE: LLL). Although the company has a lower P/E of 8.6, it's a broad-based defense contractor that lacks Smiths' market presence and advanced technology.
One potential downside to a Smiths play is the chance that privacy and health advocates will prevail in their attempts to limit use of these devices, but that is unlikely, given the high security stakes involved. Smiths Group's American depositary receipt (ADR) is a buy up to GBP1,200.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.