Material handling specialist Columbus McKinnon (CMCO) has done okay since my last update, with the shares slightly outperforming the broader industrial space. Relative to many of those peers, Columbus McKinnon has relatively lower short-cycle recovery exposure, but the company should benefit from recoveries in markets like autos and from a capex investment cycle in markets like steel. Valuation remains attractive, and I believe the Street continues to overlook this smaller name leveraged to increasing automation investment on factory floors.
A Better Than Expected Quarter, But Still Tough Overall
Expectations were low for Columbus McKinnon’s fiscal first quarter, but management nevertheless produced slightly better than expected results. Revenue beat by about 3%, with a better beat at the operating income line.
Revenue fell 34% in organic terms, driven by a 35% volume decline. Volumes declined sharply in both the U.S. (down 37%) and OUS (down 32%) as companies in almost every end-market slammed the gates on anything other than essential spending.
Gross margin declined about 330bp in reported terms, but about 150bp less on an adjusted basis. Adjusted operating income plunged 82%, with margin down 960bp, but Columbus McKinnon did at least manage to keep the decremental margin in the low 30%’s – consistent with what quality industrials have managed this quarter.
Backlog declined 11% yoy but stayed basically flat sequentially, as orders declined 30% from the prior-year. While there were a few bright spots in the order book (rail orders were up strongly), short-cycle orders declined 40% – an ugly-looking number to be sure, but not so far out of line with the order declines seen in Atlas Copco’s (OTCPK:ATLKY) Industrial Technique business (down 35%) or Sandvik’s (OTCPK:SDVKY) Machining Solutions business (down 35%). While it’s not a good apples-to-apples comparison, other companies involved in material handling equipment like Dover (DOV) likewise reported significant weakness in the quarter. On a more encouraging note, orders improved throughout the quarter and continued to improve through July – something not all industrials have been reporting (some have reported flattening recovery in July).
End-Market Trends Remain Challenging
Management said that there were signs that the U.S. auto market was improving, though still well below full capacity. I’ve been expecting the auto sector to improve in the third quarter and into the fourth quarter as part of the early stages of a more V-shaped recovery, and the auto market represents about 10% of CMCO’s end-market. For what it’s worth, a few other companies (including Dover) have likewise pointed to some signs of improving demand.
Management also said that the utility market was “improving” and this is likewise not a surprise. The utility market was one that I expected to remain relatively stronger throughout 2020, and updates from companies like ABB (ABB) have supported that basic thesis. Utility customers make up another 10% or so of CMCO’s mix.
On the flip side, it’s no surprise at all that the company’s entertainment vertical (about 3% of sales) is seeing significant weakness. With mass-gatherings still not allowed to take place, venues continue to delay and defer maintenance and upgrades to preserve cash.
Looking at some of CMCO’s other major markets, there are good reasons to remain concerned about the oil/gas market (about 10% of sales). While management said they’re seeing good project activity in the Mid-East and Asia, particularly in the crane business, I believe weakening capex budgets remain a threat.
Non-residential construction (about 5% of sales) remains mixed. It doesn’t sound like Columbus McKinnon is benefiting to the same extent from better-than-expected current activity levels, but management expects business to pick up in the third quarter. I remain concerned about the outlook for this sector in 2021/2022 as project funnels empty out.
Metal processing is a more interesting market for me. While I expect general conditions in markets like steel and aluminum to remain relatively weak in 2H’20 and 2021 on weaker prices, I do expect volumes to pick up, which should drive more material handling equipment demand. Likewise, I’d note that there is meaningful capacity coming online in the U.S. steel sector over the next couple of years that could produce growth opportunities for CMCO.
The Outlook
Columbus McKinnon still needs a short-cycle industrial recovery to do better, and I still expect that to start to materialize more toward the end of calendar 2020. This fiscal year will still likely see a sharp drop in revenue from the weakness in this quarter and the next (the midpoint of management guidance for fiscal Q2 is a 25% yoy decline), but I expect a recovery in the following years and roughly 3% long-term revenue growth. I expect Columbus McKinnon to modestly outgrow underlying U.S industrial investment growth as the company introduces more automated and automation-enabling products and gains share in newer verticals.
I also expect the company to leverage past efforts made to streamline manufacturing and sourcing, with FCF margins heading toward the low double-digits on a sustained basis.
The Bottom Line
I continue to believe that Columbus McKinnon shares should trade in the mid-to-high $30s on the basis of discounted cash flow and margin/return-driven EV/EBITDA, and I believe the prospective return from here is still attractive at a time when many industrial stocks have already been pushed hard on their recovery prospects.
Disclosure: I am/we are long ABB. 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.
