AIMC - Altra Industrial Motion Closing Out On A Mixed Note

Summary

• Altra's fourth quarter results included a few curious items, as management's calculation of organic revenue may have understated underlying growth.
• The Automation and Specialty business appeared to have posted healthy double-digit growth on solid underlying automation demand, while Power Transmission Technologies looked a bit soft relative to peers/rivals.
• Results came in at the low end of management's earlier guidance, but margins still compare well to other industrial power/motion companies.
• Regal Rexnord is getting a high-quality business that should create meaningful synergies in attractive markets like automation and precision motion.
• There's really not enough upside left in Altra shares to be worth whatever risk there is that the deal doesn't go through.

The exact timing of the close of Regal Rexnord's ( RRX ) acquisition of Altra Industrial Motion ( AIMC ) hasn't been determined, but it seems that Altra is going to close out its days as a public company on a mixed note. While it would seem that demand within the company's automation markets remains strong, the power transmission business seems like more of a laggard, and that's curious given the results at other comparable companies.

I'm not concerned about Altra's results as they pertain to Regal Rexnord, beyond the fact that 2023 may be a more challenging year for industrial companies, and particularly in the second half of the year. That could make for a modestly more challenging integration process and perhaps delay some of the synergy benefits, but I still believe this is a win-win deal for the two companies and one that will benefit Regal Rexnord over the longer term.

Untangling Some Curious Results

Altra management reported 2% organic revenue growth for the quarter, which at first glance seems like a very oddly low result compared to the results from a broad range of other motion control companies like Gates ( GTES ), SKF ( SKFRY ), Timken ( TKR ), which saw organic growth of 10% or greater, and distributor Applied Industrial Technologies ( AIT ) which reported 21% growth in its Service Center segment (which includes power transmission products).

If I'm correctly understanding what Altra presented, and as is often the case with companies approaching the close of a buyout, there was minimal commentary and no presentation or conference call, then I think the issue is the calculation methodology for organic growth. Management added back forex headwinds and took out the contributions of a small acquisition, but didn't adjust out the year-ago revenue from Jacobs Vehicle Systems. Adjust for that and revenue growth jumps to 11%, which makes a great deal more sense.

Even so, questions remain. Stripping out JVS would push growth from the Automation & Specialty business to around 12%, but that still leads to around 7% growth from the Power Transmission Technologies business. Granted, 7% organic growth is hardly a crisis, but it is weaker than what I've seen from most other power transmission/motion control companies, and it's curious in the context of healthy demand in markets like aerospace, agricultural equipment, metals/mining, and oil/gas.

My suspicion is that weakness in conveyance could be an issue. Columbus McKinnon ( CMCO ) saw a 20% decline in its specialty conveyance business on weaker demand from warehouse automation, and material handling (which includes warehouse/logistics automation) is a meaningful market for Altra.

Softening Trends In The Near Term

Management didn't offer guidance for FY'23, but did come in at the low end of its guidance range for revenue, EBITDA, and free cash flow, and there has been evidence of deceleration in the business.

A lot of revenue here comes from "general industrial", a catch-all term that typically includes a wide range of generally short-cycle businesses. Demand is clearly slowing for most companies; while fourth quarter results have been good across the sector, orders are starting to weaken (if not decline), and companies have gotten more cautious with their outlook. Add in ongoing weakness in material handling, and that's about 40% of Altra's business that's looking at a more challenging environment in 2023.

I do expect later-cycle businesses to hold up better. That includes agriculture and construction, though I think the turf market could be softer on weaker housing trends. Mining should remain fairly healthy, and oil/gas should likewise remain a good market. I also expect healthy demand from renewables (though this can be volatile), and improving demand from aerospace.

Regal Rexnord Is Getting A Good Business

Although Altra's fourth quarter had some "quirks" and the final results for the year weren't quite what I expected, I'm not concerned about the Regal Rexnord deal. Gross margin has held up pretty well here (up almost three points year over year and up 30bp qoq), and a 20% EBITDA margin for the year still compares well to many industrial companies; likewise with adjusted operating margin in the mid-teens.

Given Regal Rexnord's complementary strengths in areas like gearing, couplings, and bearings, I think there will be strong synergies in the Power Transmission Technologies business, and opportunities to leverage cross-selling, as the end-markets and customers don't fully overlap. I likewise believe that adding Altra's precision motors, motor controls, and linear systems will complement their own motor and control businesses and make the combined company a significant force in mechanical automation technology (motors, servos, actuators, and other products used in robots and other automated mechanical systems.

The Bottom Line

With only a $0.40 spread between Altra price (as of this writing) and the $62/share cash offering price, I don't see much benefit to hanging around. Altra is worth following until the deal closes as another read on multiple significant industrial end-markets, but as a stock I think this story is pretty much done, through Regal Rexnord still offers enough upside to be worth a look .

For further details see: