CMCO - Columbus McKinnon Has Outperformed As The Market Looks Past Short-Term Challenges

Summary

• Columbus McKinnon posted top- and bottom-line beats for the December quarter, but U.S. volumes remain soft and margins were a little weaker than expected.
• Weaker spending on e-commerce capex is having an impact on short-term results, as is weaker short-cycle demand, but several longer-cycle markets have held up better.
• Columbus McKinnon remains in a challenging period given softening industrial market demand, but leverage to automation-enabling technologies should drive a post-slowdown rebound.
• CMCO shares have performed well and still offer upside.

A challenging 2022 marked by supply chain issues that both limited companies’ ability to ship to demand while also hurting demand, is giving way to a 2023 marked more by slowing production and weakening end-user demand. That’s making for a challenging set-up for Columbus McKinnon ( CMCO ), and particularly so given a sharp slowdown in the warehouse expansion plans of a major e-commerce company.

I had expected some challenging quarters for Columbus, and that has been the case, with the company posting multiple quarters of U.S. volume growth below industrial production growth. Even so, the market has been willing to reward the company for its longer-term potential as an automation-enabler as it exits this more challenging period – the shares have risen close to 40% since my last update, handily beating the average industrial.

At this point I look at Columbus as more fairly-valued than compellingly undervalued, but I still like the long-term leverage to a higher-value mix (including specialty conveying and other automation-related product lines) and improved margins. Priced for a high single-digit annualized return, I think this is still a name to consider even after this recent run.

Challenging Headwinds Make For Less Obvious Progress

Columbus McKinnon’s fiscal third quarter (the December calendar quarter), wasn’t a great one, but it was still a bit better than expected and there was some evidence of progress in the business, particularly when considering some headwinds from a major customer.

Revenue rose about 8% in organic terms, which is a little below the average for industrials this quarter (closer to 10%), but certainly not close to the bottom of the list (and still about 1% better than expected). Revenue was driven primarily by pricing (up 5.5%), and the U.S. saw some volume growth this quarter after contraction in the prior quarter, though 0.6% growth is still below industrial production growth. Business outside the U.S. remains surprisingly strong, with 11% organic growth including nearly 6% volume growth.

Gross margin declined 110bp yoy and 160bp on an adjusted basis to 35.6%, with adjusted EBITDA up 11% (margin up 50bp to 14.7%) and adjusted operating income up 15% (with margin up 70bp to 10.2%). Operating income was a bit better than the sell-side expectation, but most of the reported EPS beat was driven by below-the-line items, with weaker gross margin sapping the earnings momentum.

Longer-Cycle Businesses Doing Okay, But Challenges Remain

Management’s guidance for the next quarter ($240M-$250M) was below prior Street expectations and suggests a year-over-year reported decline of 3%, but like so many other industrials, analysts and investors went into the earnings report braced for worse. As has been the case for many industrials this quarter, “less bad” is good enough for now.

Orders declined 7% year over year and were down 4% quarter over quarter as reported, but up 3% on an average daily order rate basis. Backlog rose 12% yoy and slightly on a sequential basis.

Orders have been more challenging for the company for a few quarters now. Previously the company was seeing order weakness tied to supply chain issues at customers – with customers unable to get other components and machinery they needed (not related to or provided by Columbus), there was no need to order products from Columbus. Now it seems like there’s a more general slowdown in many end markets.

It also hasn’t helped that a large e-commerce customer, presumably Amazon ( AMZN ) has significantly cut back their business with Columbus due to canceled/curtailed capacity expansion plans. It sounds as though this business could have had a roughly 4% impact on orders in the quarter, and it likewise was a big part of specialty conveying seeing a 20% decline (with Dorner down 25%) in business this quarter. Columbus isn’t the only company that Amazon’s revised plans have hurt, with Cognex ( CGNX ) and Honeywell ( HON ) also previously seeing weaker results/guidance due to revised capacity spending at Amazon.

One of the things I like about Columbus is that, while the company is sensitive to shorter-cycle end-markets and capex budgets, there are some longer-cycle businesses here that can pick up some of the slack. Management has continued to see strength from end-markets like entertainment, utility, energy, oil/gas, defense, and life sciences that are either longer/later-cycle (like oil/gas) or largely acyclical (like life sciences).

I’m a little surprised that food/beverage isn’t stronger at this point, likewise with chemicals and pulp/paper, but not all end-markets benefit all suppliers simultaneously. I would expect ongoing healthy trends in areas like utility and oil/gas, and I would also expect Columbus to benefit from improving aerospace demand, as well as ongoing growth in EV production. I do expect shorter-cycle industrial trends to bottom out in the fall, at which point “general industrial” should show improvement for Columbus.

The Outlook

Between some challenging quarters since my last update and softer guidance, my revenue and margin expectations for Columbus McKinnon are weaker in the short term, but not dramatically different longer term, as I think there will be a pickup in demand on the other side of this slowdown. Likewise, I continue to believe in the company’s pivot toward a portfolio of higher-value automation-enabling products. I expect low single-digit revenue growth in FY’23 and FY’24, but a rebound in FY’25 and FY’26 and longer-term growth in the 4% to 5% range.

Margins have flattened out a bit for now, but the company continues to move forward with process/cost improvement efforts. I expect EBITDA margins to regain momentum in FY’25 and resume a path toward the high teens over the next three to five years. Longer term, I still expect low-double-digit FCF margins on an ongoing basis, driving normalized FCF growth in the high single-digits.

Between discounted cash flow and margin/return-driven EV/EBITDA, I still see some upside in these shares. Cash flow suggests a long-term annualized total potential return in the high single-digits (pretty good for an industrial after this recent rally), and a 10.75x forward multiple supports a fair value of around $44, with some rerating likely over the next couple of years as margins improve further.

The Bottom Line

Columbus McKinnon shares don’t offer the same upside I saw back in mid-2022, but then the shares have had a good run since then. I do think uncertainty and weakening end-markets in 2023 is a risk, not just for this company but the larger industrial space, and I have some concerns that in the short term, stock prices may have overdone it in this “relief rally”. Still, while I can see the appeal of trying to wait for a pullback, I think the shares still offer decent upside from here and good exposure to an arguably overlooked long-term enabler of industrial automation through better lifting, conveying, linear motion, and power control solutions.

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