AIN - Albany International: Despite Operational Improvements I Am Wary Of Valuation

Summary

• Albany has done well to improve profitability and reduce debt over the past decade.
• Mixed together with rising aerospace exposure and geopolitical conflicts the world over, the valuation has risen to highs.
• Unfortunately, more data suggest poor returns from current levels; so I would hold/not add to a position.

Introduction

Albany International ( AIN ) is an industrial company designing materials for use in aerospace and paper production processes. On the paper side, the company produces consumable belts that paper manufacturers use in their creation processes, and Albany is the market leader at around 30% share. The other revenue segment designs composite materials that are used across the industry, including Boeing ( BA ) aircraft bodies, GE Aerospace ( GE ) engines, and Lockheed Martin's ( LMT ) F-35. The unique mix of two non-correlating industries is certainly a great way for investors to diversify.

Due to the exposure and high-tech advantages, Albany has increased in value over the past five or so years. Part of this can be attributed to financial improvements such as increasing margins and a healthy balance sheet through debt reduction. As such, I believe that over a longer period, 5-10 years, the investment is completely bullish. However, the problem will be whether the company can maintain form through the current bear market as they have yet to sell down. This article will point out the factors that may weigh on the price moving forward.

The Valuation Leaves Little Room For Upside

Thanks to improvements and market favorability for aerospace/defense-adjacent investments, Albany's valuation is reaching record levels. In fact, the EV/EBITDA is now approaching 12.4x, a level only seen a few times in the past. Also, the P/S ratio has been on a linear up-trend since the financial crisis as margins have been improving. Unfortunately, based on the historical pattern, when Albany reached a high valuation returns were poor over the next few quarters. In fact, I expect that the valuation may decline by 25-30% if the company begins to sell off.

Risk Points to the Valuation

Revenue Growth

The problem for Albany investors is if the company reverts to historical growth rates. The company has not fared well over the years, with quarterly revenues still below the peaks seen in 2008. Also, between 2010 and 2018, Albany had a negative 10-year average revenue growth rate, although that has risen to 3% annualized growth per year over the past 10 years. At the peak of the pre-pandemic bull market, revenues grew 10-15%, but that is under stellar conditions. Overall growth is certainly low no matter what time frame you look at, not to mention cyclical.

Therefore, with impending recessions and bear markets across industry and the markets, I believe that only negative sentiment is in store moving forward. This is even as the war in Ukraine adds some sentimental stimulus to suppliers. Thankfully, revenue growth is not the only influential metric on the share price.

Bottom Line Weakness

While revenues have been slow to keep up over the years, Albany has done well to improve margins and drive earnings growth. The EBITDA margins have risen over the past 10 years from 15-20% to 25-30% on a quarterly basis. This has led EBITDA to grow at an annualized rate of 6.5%, or more than twice the rate of revenues.

Net income has fared even better, with the NI margin improving from the low-single digits to around 10%. This has led to net income growing at an annualized rate of 21% per year, 12.6% on a normalized basis. Either way, growth on the bottom line has been swift and the cause for most returns over the past decade.

These improvements have been thanks to operational improvements and changes to the revenue segments and so I believe the progress may continue, and or stay around current levels. However, with a bear cycle, the risk for negative earnings will return despite this. In particular, there are issues with the major customer base that may suggest either a pullback in spending or cost-cutting on contracts.

Customer Markets Weak

First, the core business of industrial belts is cyclical despite the exposure to necessities such as tissue paper and cardboard. As is typical, high prices do not last long, and the current peak paper prices will fall as interest rates drop demand. The down cycle will cause Albany's clients to pull back on production, and the need for belts and other products will cause Albany to lose revenues.

Thankfully, the impacts will be reduced due to the fact that Albany is the leading supplier, the products are essential for the industry, and are consumable products that cannot be hoarded by customers during weak times. It is just hard to believe that prices will remain elevated, and the top line will certainly be affected to a degree.

Delays in Commercial Aircraft

Other downside may be due to poor finances and sentiment relying on Albany's relationship with Boeing. The pandemic has almost ruined the company, despite a strong rebound in travel demand. BA has not been able to keep up and slow production and output has caused delays and increased costs within the airline industry. In fact, airlines are now falling back on recently retired jumbo jets, particularly Airbus's A380, to meet demand. As per DW :

The Airbus A380, the world's biggest airliner with over 600 seats on board (in one specific Emirates airline configuration) had been written off by many observers and retired by numerous airlines at the height of the pandemic. But now, as airlines seek ways to cope with the sudden massive increase in demand and the delivery delays plaguing Boeing, the superjumbo returns and in much larger numbers than expected.

Apart from Albany not seeing purchases from Boeing due to slow production, the delays are weakening the industry as they must invest in old, expensive inventory such as the jumbo jets. According to the Seattle Times and Airline Weekly , the costs are extensive and are negatively influencing the entire industry. No one knows how this will influence spending through the back half of the decade. Defense contracts are also in the line of fire, signaling that the bear market in airlines may be lasting, despite the high demand.

Conclusion

While Albany looks attractive thanks to their moat in paper belt supply, advanced materials for the aerospace industry, and significant operational improvements and debt reduction, I believe that the risk is skewed towards short-term weakness. Then, there is the risk that overall revenue growth will not be able to provide enough momentum over longer time frames to support continued earnings growth over 10%. I would hesitate to recommend buying at current levels.

However, the opportunity is viable if the company maintains form and their clients perform well. Current news goes contrary to this and I will not gamble. If shares fall, perhaps a far lower valuation would be enticing. There are certainly better opportunities out there in my eyes.

If you are a current shareholder, then perhaps continuing to add on a regular basis will fare well if the drawdown is not severe. Perhaps the advancements in new aerospace products will be enough organic growth providers to negate the potential decline in valuation. Unfortunately, I don't see a solid thesis over the next 1-3 years so I will remain on the sideline.

Thanks for reading. Feel free to share your thoughts below.

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