EnPro Industries (NPO) is an undercovered stock on this research platform and given that the company announced quite a substantial acquisition, it is time to have a look at EnPro, a business which finds itself in a continued state of transformation as it seems.
The Company – An Overview
EnPro provides highly-engineered solutions for mission-critical applications in a range of fields, including chemicals, automotive, aerospace, laboratory solutions and chip manufacturing. The company generated $1.2 billion in sales in 2019, of which three quarters came from sealing products, with the remainder coming from engineered products.
While the company relies largely on the US, with two-thirds of sales generated here, there is some real diversification as sales are split in half through OEM and aftermarket supplies, on top of the fact that the company has exposure to a range of industries.
The sealing business generates approximately $900 million in sales with 18% EBITDA margins (talking segment margins here) with offerings focusing specifically on oil seals, high performance seals, suspension components, semiconductor subassemblies, among others. Engineered solutions is a $300 million business with similar 16% EBITDA margins focusing on metallic and composite bearings and compressor products. Despite this diversified product and customer base the company is far from isolated in the current environment. EnPro has quite a few large customers feeling some turmoil including Boeing (NYSE:BA), Schlumberger (NYSE:SLB), Shell (NYSE:RDS.A) (NYSE:RDS.B), Volkswagen (OTCPK:VWAGY) and Airbus (OTCPK:EADSF), offset only to a smaller extent by companies which are doing (relatively) well including Deere (NYSE:DE), Applied Materials (NASDAQ:AMAT) and SpaceX (SPACE).
The company tries active portfolio management to keep adjusting the portfolio to growth areas, seen in health, semiconductor and aerospace, at times announcing bolt-on acquisitions and divestments to steer the tanker.
Nonetheless, the performance in the long run is a bit disappointing. After all, revenues now come in at the same level as they did in 2012 amidst a flat share count, indicating no revenue growth on a per share basis for nearly a decade. This disappointment is confirmed as margins are largely similar to the levels a decade ago, despite focus on higher value-added activities.
The Actual Numbers
In February of this year, just weeks before the Covid-19 outbreak was in full swing, the company reported its 2019 results. These were quite soft with sales down more than 5% to $1.21 billion and while a $169 million adjusted EBITDA number looks compelling, it only translates into net earnings of $56 million on an adjusted basis, or $2.68 per share (essentially flat compared to 2018).
Problematic is that GAAP earnings only came in $0.38 per share, leaving a huge gap as a result of restructuring costs, environmental remediation charges and debt extinguishment costs. These appear quite structural, but at least the company is not adjusting for massive stock-based compensation expenses which are truly structural, as is common practice in any (technology) IPO these days.
The situation does not look very compelling, however, at first sight. On top of a net debt load little over half a billion dollars, which worked down to a 3 times leverage ratio, the earnings numbers were highly distorted. This was reflected in the share price already with shares starting the year around $60, actually down below a previous high of $70 in 2011 and high of nearly $100 early in 2017. Ever since, investors had to digest quite some disappointments over time, including a lack of structural growth. The company guided for better days with EBITDA seen at $180-190 million this year and adjusted earnings of around $3 per share at the midpoint of the range, as based on these numbers shares do not look very attractive, certainly given the track record or lack thereof.
While reading the 2019 earnings release, this picture painted above is not accurate as the company announced a significant divestment late in 2019, closing in January of this year. The company sold Fairbanks Morse for $450 million (equal to nearly its entire net debt load) at a 10.5 times EBITDA multiple, suggesting about $43 million in EBITDA will leave the door, yet Fairbanks was already classified as a discontinued operation in 2019.
This makes the situation look much more compelling as leverage is far lower than assumed. That being said, the comment made by management that leverage ratios will drop from 3.0 to 0.8 times as a result of the deal, is a bit disappointing. This suggests net proceeds of the deal around $370 million, indicating quite some ”leakage” in taxes or transaction costs.
The deal for Fairbanks might have been a lifesaver for the company with Covid-19 being in full swing just weeks after closing on the big divestment. In March, shares fell to just $30 in a knee-jerk reaction, only to gradually gain ground to levels around $57 at the moment of writing, almost approaching the pre-Covid-19 levels. In the meantime, first-quarter results came in largely as expected, at least according to expectations which one could have in such an environment. In June the STEMCO Brake Products Business was exited, triggering $12 million in charges as in August the company sold the STEMCO Air spring unit in a deal which could be valued as high as $40 million.
So with these continued actions taking place, but mostly the Fairbanks deal having closed earlier this year, leverage was no major issue. By the end of the second quarter net debt came in around $70 million, yet sales had already fallen to a run rate around $1 billion. With operating earnings coming in roughly flat, interest expenses created a small loss, although truth be told, things could have been worse.
A big deal and another step in portfolio optimization (as by far not all core businesses owned meet the stringent criteria of niche engineered segment with strong margins) was announced in September. The company is paying $255 million to acquire Alluxa, an industrial company focusing on specialized optical filters and thin film coatings used in technology, life science and semiconductor industries. Unfortunately, the most important details (revenues, margins) will only be shared upon release of the third-quarter results, quite a shame.
Of course, this is the right strategic step yet the company probably paid a far steeper revenue multiple than the little over 1 times sales multiple at which the company trades itself, as the transition is a continuing story. Furthermore, it does not look as if revenues will quickly surpass the $1.2-billion mark again. Another small concern is that net debt will jump to more than $300 million overnight, not a big issue at this moment, yet it might be painful if Covid-19 will result in real economic hard times.
Truth of the matter is that the company is making a big deal here, equal to about 20% of the value of the firm, yet refuses to provide more information on the transaction, never a great sign.
Furthermore, the incurred leverage is a risk in this environment as I am far from impressed with the long-term value creation skills of the management, hence the reason why shares have been a laggard for quite a while now. Amidst all of this, uncertainty in the core business and a full valuation (at least in terms of adjusted earnings numbers), I see no reason to get really involved here and now. That being said, I look forward to learning more about the transition in the coming quarters, but for now am not compelled to get involved.
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Disclosure: I/we 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.