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Even allowing for some challenges in the linear motion market and Altra’s (AIMC) particular end-market exposures, I’m surprised that Altra’s share price has been as weak as it has been. Down more than a third since my last update, Altra has significantly underperformed the wider industrial sector, as well as partial comparables like Regal Rexnord (RRX) and RBC Bearings (ROLL), though the latter’s performance was tracking pretty closely to Altra’s before fourth quarter earnings.
I can understand caution with Altra’s meaningful exposure to short-cycle markets (“distribution”), heavy vehicle, medical, and wind power markets, but I think the company’s leverage to factory and warehouse automation, ag & construction, food/beverage, packaging, and improving aerospace should be worth more than this. The sale of Jacobs does lower my long-term revenue growth rate to around 4%, but that, combined with longer-term margin improvement should still be enough to support a fair value well above today’s price.
Mixed Revenue, With Weaker Margins
Altra shares had been sliding for some time, but the rate of decline has steepened since fourth quarter results, and management guidance wasn’t particularly bullish for the near term.
Revenue rose 4% in organic terms in the fourth quarter, good enough for a modest 2% beat versus Street expectations, but the growth rate was about half that of the “average” industrial stock this quarter, though more in line with Regal Rexnord’s 5% organic growth in Motion Control Solutions. Power Transmission Technologies (or PTT) saw 13% organic growth, while Automation & Specialty (or A&S) saw 4% organic contraction.
Gross margin declined about two points from the year-ago level and 260bp sequentially to 33.6%, as the company was hurt by adverse mix and higher supply costs. Management wouldn’t give clear guidance on pricing actions, but did say that pricing actions have lagged cost increases, creating a roughly 100bp lag in the fourth quarter.
Adjusted EBITDA declined 9%, with margin falling about two points to 18.6% (Regal Rexnord’s Motion Control Solutions posted a mid-20%’s EBITDA margin). Operating income declined 13%, with margin down almost three points to 14.4%.
Segment profit declined 8%, missing by more than 5%, with margin down about two points to 15.5%. PTT profits rose 23%, with margin up 120bp to 14%, while A&S profits fell 24%, with margin down 460bp to 16.9%.
Management guided to organic growth of 5% to 7% for FY’22, a little below sector-wide averages, and likewise a bit below prior sell-side expectations. On the margin side, guidance for flat EBITDA margin implies an EBITDA target about 3% below where the Street was before.
A Tale Of Very Mixed Markets
The weakness at Altra seems to be driven in large part by significant declines in the Chinese Class 8 truck market, challenges in the ex-China truck market tied to component shortages, weakness in wind power, and tough comps in the medical business – with much of this concentrated in the A&S space, that goes a long way toward explaining the sharp split in organic revenue and margin performance.
I don’t expect a quick turnaround in the Chinese truck business; Cummins (CMI) guided to a 30% year-over-year decline in Chinese heavy and medium-duty trucks for 2022, and Cummins is usually pretty candid about their thoughts on that market. Markets like North America and Europe should be stronger as component shortages ease, but at best this is a market that has bottomed out.
Regal Rexnord called out similar weakness in wind power, and while this industry still has a good future, a near-term turnaround in the business seems unlikely unless China gets more aggressive again on incentives. The headwinds in the medical business should fade as tough comparisons roll off, but it will take some time for leverage to markets like robotics to generate better growth.
On the more positive side, Altra still has good exposure to factory automation (over 10% of revenue), and companies like Rockwell (ROK) continue to point to strong demand for discrete and hybrid automation, and markets like food/beverage and packaging continue to spend on facility modernization and capacity expansion. Companies like Fanuc (OTCPK:FANUY), Teradyne (TER), and Yaskawa (OTCPK:YASKY) likewise all gave healthy outlooks for robotics demand.
Altra generates another 10% or so of its revenue from the ag, construction, and turf markets, and demand here remains healthy, particularly in ag. Material handling, too, remains strong as companies continue to invest in factory and logistics/warehouse automation. Aero wasn’t a strong market for Altra this quarter, but with commercial plane production schedules improving, demand should be better in 2022 and 2023, driving a recovery in this business.
Underlying the above, Altra had a book to bill of 1.11x in the quarter and exited with a backlog in excess of $800M against expected full-year revenue of around $2B.
Active On Both Sides Of M&A
Altra has been a little more active of late in M&A. The company acquired Nook Industries, a small niche player in engineered linear motion with exposure to medical, factory automation, and defense markets that fits in well with Altra’s existing niche linear motion operations.
The company also announced the sale of Jacobs Vehicle Systems to Cummins for $325M. Altra is going to miss a business that generates mid-20%’s EBITDA margins (above the company average), but it wasn’t a core operation for Altra, nor one that really fit with the rest of the business (it was acquired as part of the acquisition of A&S from Fortive (FTV)).
What I don’t understand is why the company is only getting around 7x trailing EBITDA for the business – operating margins at Jacobs should be at least in the high-teens, arguing for a double-digit multiple. I understand that this isn’t a great time to be selling a commercial vehicle components business, and there likely weren’t an overabundance of strategic bidders, but I’m surprised that management was willing to sell for that price.
The Outlook
Modeling in the impact of the Jacobs sale will reduce apparent revenue growth in the short term, but Altra’s leverage to markets like factory automation (including robotics), ag, material handling, and aerospace should be sufficient to support mid-single-digit long-term revenue growth. There is some risk here to slowing growth in short-cycle end-markets, but I believe automation is a multiyear trend, and I do expect better results in aerospace.
I’ve reduced my near-term margin estimates on the impact of higher costs and the sale of Jacobs. I expect FCF margins in the 10%’s for a couple of years, but I do expect margins to scale up toward the 13%-14% range over time, magnifying around 4% to 4.5% core revenue growth to over 8% FCF growth.
The Bottom Line
Between discounted cash flow and margin/return-driven EV/EBITDA (supporting a forward multiple of 12.5x), I believe Altra shares should be trading closer to $60 than $40, and I expect a double-digit annualized total return from these levels. Clearly the Street does not agree, and I can understand the caution around short-cycle distribution and heavy vehicles, but that is at least partly offset by exposure to markets like factory and warehouse automation and aerospace. Sentiment is clearly an issue here now, but patient contrarians might want to take a closer look.
