GTES - Barnes Group Can Only Soar So High

Summary

• Barnes Group has done incredibly well in recent months, with shares soaring despite some weakening in its financial data.
• Due to the nature of the weakness, though, investors should not worry too much, but this doesn't mean the company is as appealing as it once was.
• At present, shares look fine, but there are likely better prospects to be had now.

2021 proved to be a rather difficult year for most investors. But there were some companies that have, at least near the end of the year, demonstrated some rather robust performance. One great example of this is industrial components and services business Barnes Group ( B ). Operationally speaking, the company produces molding solutions, engineered components, force and motion control technologies, automation technologies, and various aerospace parts for both OEMs and aftermarket customers. Most recently, financial performance for the company has been impaired some, with revenue and profits dropping slightly. At the same time, shares of the company have been fairly attractive on an absolute basis. But given a recent increase in share price and the aforementioned deterioration in bottom line results, I do think that investors should be a bit more cautious moving forward. Because of this, I've decided to decrease my rating on the company from a ‘buy’ to a ‘hold’ to reflect my view that shares should generate returns that more or less matched the broader market for the foreseeable future.

A change of opinion

The last time I wrote an article about Barnes Group was back in early August of 2022. In that article, I talked about how the company had not fared particularly well since I had written about it previously in November of 2021. Mixed fundamental performance had proven painful for investor sentiment. Although I acknowledged that the company probably deserved to see some of the pain laid on it, I felt as though shares were looking cheap enough to offer attractive upside for investors moving forward. Since then, the company has done incredibly well. While the S&P 500 is down 8.3%, its shares have generated upside for investors of 20.7%. For context, since my article on the company in November of 2021, shares have seen downside of only 1.3% compared to the 18.3% experienced by the S&P 500 over that same window of time.

When I last wrote about Barnes Group, we only had data covering through the second quarter of its 2022 fiscal year. Fast forward to today, and that data now extends through the third quarter . During that quarter, sales came in at $314.7 million. That's 3.2% lower than the $325.1 million in revenue generated the same time last year. This drop, accounting to $10.3 million, came even as organic sales for the company jumped by $7.8 million, or 2.4%. Most of this was driven by an 18.5% surge in its aerospace operations, some of which was offset by a 4.1% decline in its industrial business. The real pain for the company didn't come from its core operations but, instead, was driven by foreign currency fluctuations. This is, in itself, rather positive since it has less to do with the company's operations and more to do with factors outside of its control that should be one-time in nature.

With the drop in revenue came a decline in profitability. Net income in the latest quarter was only $17 million. That compares to the $27.9 million reported the same time last year. One big driver of this pain was a drop in the company's gross profit margin from 36.9% to 33.7%. According to management, this drop was primarily the result of decreased sales volume, unfavorable productivity, supply chain issues, and inflationary pressures all within the industrial segment. Within the aerospace business, higher volumes associated with the company's aftermarket operations helped to offset this to some degree. Selling and administrative expenses also hit the company, with there are numbers rising from 23.5% of sales to 24.2%. This, management said, was mostly driven by a $7.2 million pretax charge related to restructuring and workforce reduction actions. Sadly, other profitability metrics followed suit. Operating cash flow dropped from $42.1 million to $35 million. If we adjust for changes in working capital, it would have declined from $54.4 million to $44.7 million. Even EBITDA took a hit, dropping from $65.8 million to $51.7 million.

Although revenue for the first nine months of 2022 is still higher year over year than they were last year, having risen from $947.8 million to $948.4 million, the profit figures for the year-to-date period look similar to what the company experienced during the third quarter alone. For instance, the $2.1 million net loss experienced during this time pales in comparison to the $71.7 million profit achieved the same time last year. Operating cash flow dropped from 127.8 $1,000,000 to $43.5 million, while the adjusted figure for this declined more modestly from $148.5 million to $144.7 million. Meanwhile, EBITDA also took a step back, dropping from $178.7 million to $166.5 million.

When it comes to the 2022 fiscal year in its entirety, management does expect sales to come in higher, with organic revenue of between 5% and 6% being offset largely by a 4% hit associated with foreign currency fluctuations. Adjusted earnings per share, meanwhile, should come in at between $1.90 and $2. That would imply adjusted net income of $99.6 million at the midpoint. No guidance was given when it came to other profitability metrics. But if we annualized results experienced so far, we should anticipate adjusted operating cash flow of $196.2 million and EBITDA of $219 million.

Based on these figures, the company is trading at a forward price-to-earnings multiple of 20.8. The forward price to adjusted operating cash flow multiple is 10.6, while the EV to EBITDA multiple should come in at 11.7. To put this in context, you can see, in the chart above, how these numbers stack up against the valuation of the firm if we were to use data from 2021 instead. As part of my analysis, I also compared the company to five similar businesses. On a price-to-earnings basis, these companies ranged from a low of 5.2 to a high of 21.9. Four of the five companies are cheaper than Barnes Group. Using the price to operating cash flow approach, the range was from 5.2 to 32.4. In this case, our target is cheaper than all but one of the five firms. But when it comes to the EV to EBITDA approach, the range is between 3.2 and 11.4. In this case, our prospect is the most expensive of the group.

Takeaway

Based on all the data provided, I will say that I believe the long-term picture for Barnes Group is still likely positive. Having said that, shares have had a nice run and, while they are still affordable on an absolute basis, they are looking pricey compared to similar firms using two of the three valuation approaches that I utilize. To be fair, a lot of the company's problems most recently have been one-time events, such as foreign currency fluctuations, restructuring costs, and more. But even with that being the case, and with the market only getting more uncertain as the days go on, I think that it would be appropriate to downgrade the company from a ‘buy’ to a ‘hold’.

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