CMI - Atmus Filtration: Tackling Investor's Concerns

2023-12-11 03:51:29 ET

Summary

• Atmus Filtration, the former filtration business of Cummins, reported positive second-quarter results after its IPO, alleviating investor concerns.
• The company provides filtration products for commercial vehicles and power generating vehicles, targeting a market estimated to be around $13 billion.
• Despite some uncertainties, ATMU's earnings and sales have remained steady, resulting in cheap valuations amidst a non-compelling growth outlook.

In September, I concluded that the first reading after the IPO of Atmus Filtration ( ATMU ) looked positive. The former filtration business of Cummins reported positive second quarter results, alleviating concerns that investors had at the time of the spin-off.

While there still were some concerns about the corporate cost overhang and slower growth in the second half of the year, the third quarter results alleviated some of the concerns, meaning that Atmus looks quite cheap although strong growth (positioning) likely is hard to find.

A Recap

Atmus was the filtration business of engine manufacturer Cummins ( CMI ) which spun off its filtration business in May in an initial public offering. The business provides filtration products for on-highway commercial vehicles and off-highway agriculture, construction, mining and power-generating vehicles. These filtration products are used to lower emissions and improve asset protection, with many of these products sold under the Fleetguard brand.

With a heritage of some 60 years, the company generates about $1.5 billion in sales per year, mostly related to fuel, but complemented by lube, air, ventilation, chemicals, and hydraulics as well. The company targeted an addressable market of $13 billion in an overall filtration market estimated to be around $70 billion.

While electrification is a long-term threat to the business model, it is actually somewhat of a driver as well, as much equipment has seen more stringent emission standards before getting electric. The company provides its products typically to large OEMs like Deere, Daimler, Komatsu, and its former parent company.

The company sold 14 million shares at $19.50 per share, as a total share count of 83 million shares valued equity of the firm at $1.62 billion at the IPO price, although this number excluded a $540 million net debt load. The resulting $2.2 billion enterprise valuation was applied to a business that generated $1.56 billion in sales in 2022 on which it posted operating profits around $200 million.

With EBITDA reported at $234 million, leverage ratios came in around 2.3 times, as earnings power came in around $1.50 per share. First quarter sales for 2023 rose another 10% to $418 million, with operating profits improving some $14 million to $58 million, making realistic earnings trend around $1.70 per share in my calculation after accounting for interest expenses.

By September, shares traded at $22, the same level as the first day of trading. The company has just reported second quarter sales of $414 million, up 5% from the year before. Operating profits rose some 10% to $64 million, but net earnings fell to $46 million after accounting for interest expenses, with earnings reported equal to $0.55 per share.

The company guided for sales for 2023 to come between $1.58 and $1.63 billion, which suggested that sales were seen flattish in the second half of the year after showing solid growth in the first half of the year. EBITDA was seen at $285 million, comforting, with net debt trending around half a billion.

Full year adjusted earnings were seen between $2.05 and $2.25 per share, which looks better than it was, but this comes after earnings already came in at $1.31 per share in the first half of the year. The resulting $0.84 per share outlook for the second half suggests either slower growth or greater corporate cost overhang.

So despite the green shoots of better earnings, there were still some questions to be answered before getting involved, mostly relating to the guidance for the second half of the year.

Stagnation

Since September, shares have initially moved lower from $22 to the $18 territory in October, before rebounding to $23 per share at this moment in time.

In November, Atmus posted third quarter sales of $396 million, a modest decline from a $401 million number reported in the third quarter of 2022. Gross profits improved modestly, but the added corporate cost overhang meant that operating profits fell from $65 million to $59 million as incurred debt (and interest expenses) meant that net earnings fell to $38 million. This is equal to $0.45 per share, with adjusted earnings (for one-time separation costs) reported at $0.52 per share.

Following the release of the results, the company hiked the full year sales guidance to $1.600-$1.625 billion, with adjusted earnings seen between $2.20 and $2.30 per share, up ten cents at the midpoint of the range. Adjusted EBITDA is now seen close to $295 million, comfortable, as net debt ticked down to $461 million.

And Now?

With the adjusted earnings number looking quite clean, including only about $0.20 per share adjusted for (one-time) separation costs, investors are relieved to see a modest corporate cost overhang, which is always a big question mark post a spin-off. With leverage ratios down from 2 and change to about 1.5 times EBITDA here, the company now trades at just 10-11 times earnings, even after a recent rally, all of which looks quite non-demanding.

This comes as the guidance looks conservative and earnings are quite clean, even as growth is slowing down. Hence, the business does quite well, mostly as the feared headwinds to earnings have not really materialized, although the long-term lack of growth positioning remains a considerable drag.

Given all this, I am tempted by the low earnings multiple but simply require shares to fall to high single-digit earnings multiple (at levels in the high teens) or obtain more faith in long-term growth or stabilization, as some end markets are really suffering from a poor growth outlook.

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