NPO - EnPro: Focusing On Advanced Surface Technologies And Undervalued

Summary

• EnPro Industries designs, researches, manufactures, produces, markets, and distributes a huge variety of products that serve different industries.
• I assumed that EnPro would continue to increase the size of the Advanced Surface Technologies segment, which offers significantly more EBITDA margin than the Sealing Technologies Segment.
• EnPro Holdings acquired NxEdge, which offers solutions to semiconductor OEMs and IDMs. Considering the current state of the balance sheet, I would be expecting more acquisitions in the same line.

EnPro Industries, Inc. ( NPO ) serves large customers in very different industries, target markets, and regions, which makes the company’s business model significantly diversified. It is also worth noting that management is undertaking several divestitures and acquisitions to refocus its activities to gain recurrent revenue and higher EBITDA margins. Even taking into account potential risks from inflationary raw material costs and changing regulations, the company appears undervalued.

EnPro Produces A Significant Number Of Products For Clients In Many Industries

Companies dedicated to the production and distribution of products including high technological development usually have something special due to the level of specialization required and the diversity of industries to which they can offer them, being present in a large number of artifacts present in people's lives, ranging from medical products to food as well as industrial machinery or processes for power generation. In this case, we are talking about EnPro Industries, which designs, researches, manufactures, produces, markets, and distributes a huge variety of products that serve different industries.

More in particular, in the year ended September 30, 2022, 44% of EnPro’s sales were generated by the Sealing Technologies business segment, and 56% were reported by the advanced surface technologies business segment.

The markets served appear well diversified. Clients from the semiconductor industry, general industrial, the heavy-duty truck industry, food and pharma, and aerospace buy products from EnPro. In my view, considering the level of diversification, EnPro’s future revenue line will be less volatile than that of competitors operating in small niches of the market.

Geographic Diversification And Large Clients

As important data in this sense, we can highlight that in the three segments, at least 30% of its operations were carried out in territories outside the United States, where EnPro has 4 production plants. 7 production plants are distributed among China, Germany, Mexico, France, and Slovakia. This of course indicates the successful expansion not only in the positioning of its products but also in the expansion of production territories through its industrial research and development plants.

We can also highlight some of the names of its largest clients, such as Bayer ( BAYZF ), General Electric ( GE ), and Chevron ( CVX ), which acquire products from the Sealing Technologies segment. With large brands already trusting EnPro’s products, I would say that more investors will likely have a look at the company’s financial prospects.

EnPro’s Guidance And Market Estimates

Considering the recent guidance, I believe that having a look at EnPro right now appears beneficial. Management noted that adjusted EBITDA of $253-$260 million could make a lot of sense. Besides, EnPro reported increased EPS guidance of $6.55-$6.9.

Market analysts appear a bit more optimistic than EnPro’s management. Estimates included net sales of $1.188 million with net sales growth of 4.49%, in addition to 2024 EBITDA of $276 million with an EBITDA margin of 23.23%. EBIT could be $174 million with an operating margin of 14.60%, EBT of $151 million, and a net income of $108 million. Finally, FCF could stand at $164 million together with a FCF margin of 13.80%.

Balance Sheet

As of September 30, 2022, the company reported cash worth $166.2 million along with accounts receivable of $151.4 million, inventories of $150.2 million, and current assets of discontinued operations of $148.4 million. Total current assets are equal to $650.6 million, close to two times the total amount of current liabilities. Hence, I wouldn’t expect any liquidity issue any time soon.

Property stood at $170.5 million with goodwill worth $919.2 million, other intangible assets of $811.5 million, and other assets of $142.8 million. Finally, total assets stand at $2.69 billion.

The liabilities included current maturities of long-term debt worth $15.5 million, accounts payable of $72.9 million, and accrued expenses of $129.1 million. Accompanied by total current liabilities of $253.3 million, the long term debt stands at $868.1 million with a tax deferred of $148.8 million. Finally, total liabilities are equal to $1.378 billion, implying an asset/liability ratio close to 2x.

EnPro’s total amount of debt could be worrying for certain investors, but not for me. Let’s keep in mind that EnPro’s EBITDA margin appears sufficiently stable to justify the current level of debt.

Base Case Scenario: Enlargement Of The Advanced Surface Technologies Segment And Working Towards More Recurring Revenue Generation Will Likely Enhance FCF Expectations

Under my base case scenario, I assumed that EnPro would continue to increase the size of the Advanced Surface Technologies segment, which offers significantly more EBITDA margin than the Sealing Technologies Segment. In this regard, let’s mention that EnPro is making acquisitions to accelerate growth. Last year, EnPro Holdings acquired NxEdge, which offers solutions to semiconductor OEMs and IDMs. Considering the current state of the balance sheet, I would be expecting more acquisitions in the same line, which would most likely push the EBITDA margin up.

On December 17, 2021, our subsidiary, EnPro Holdings, Inc., completed the acquisition of all issued and outstanding membership interests of TCFII NxEdge LLC. NxEdge is a leading supplier offering a set of integrated capabilities with unique processes resulting in a broad range of qualifications at top customers. NxEdge is included in our Advanced Surface Technologies segment. Source: 10-Q

Besides, under this scenario, I assumed that the company’s pricing initiatives and strategies to enhance operating leverage on organic sales growth will be successful. Let’s also point out that in the last quarterly report, management mentioned that further divestitures may take place soon. In my view, if EnPro successfully refocuses on activities that bring recurring revenue and strong cash flow, FCF expectations will likely trend north.

We will consider making additional divestitures over time, and under the right circumstances, to further our long-term strategic goals of refocusing our portfolio on businesses with leading technology, compelling margins, strong cash flow, and high levels of recurring revenue that serve markets with favorable secular tailwinds. Source: 10-Q

Under my financial model in this scenario, I assumed 2033 net sales of $1.419 billion together with net sales growth of 2%, EBITDA of around $312 million, and EBITDA margin of 22%. 2033 Free cash flow will likely be close to $209 million with FCF margin of 14.7%.

If we assume a discount of 5%, the implied NPV of FCF would be $1.537 million. Now, if we also assume an EV/EBITDA multiple of 13x, the terminal value would stand at $4.061 billion, and the net present value of terminal value would be $2.3 billion.

With these numbers, I obtained an enterprise value of $3.911 billion along with equity of $3.209 billion. The resulting fair price would be $154.3 per share with an IRR of 3.66%.

Bearish Case Scenario: Lack Of Innovation, Failure To Offer Differential Technological Value, Or Inflationary Raw Material Costs Could Imply A Valuation Of $73.7 Per Share

EnPro’s employees should play a fundamental role with regards to the future of the company, not only because of their business skills and the ability to forge agreements that allow them to position their products or generate production at a lower cost, but also mainly because of the current strategy of EnPro. This has to do with the objective of developing products with differential technological value, and to meet this objective, specialists will have to respond to great challenges with a greater degree of efficiency. Failure to do so would jeopardize the company's strategy, which lives with a highly competitive market in any of its segments, a market that has a very low tolerance for errors in the field of industrial infrastructure. In this sense, EnPro relies on the history and recognition of its products, which have served large industries throughout the last decades.

We can also add that a part of EnPro's business is currently driven by commercial relations with the United States government, and a change in policies or agreements in this regard could be controversial for the company's operations. Finally, it is good to add that EnPro is a supplier of industrial devices that are fundamental pieces in industrial operations. On the one hand, the possible latent failures of one of its products could affect the recognition and reputation of the company. On the other hand, most of these industrial activities are subject to possible variations or changes in the regulations on environmental pollution and waste management, both inside and outside the USA. In this sense, EnPro may have to know how to adapt to the new needs of the industry.

Finally, under this scenario, I also assumed that EnPro may continue to suffer from inflationary raw material costs and rising labor expenses. These issues were reported in the last quarterly report, so it is likely that EnPro sees the same from 2023.

Under this scenario, I included 2033 net sales of $968 million together with net sales growth of -2.25%. Besides, I included an EBITDA of $194 million with 2033 EBITDA margin of 20%. Free cash flow would stand at $131 million accompanied by a 2033 FCF margin of 13.50%.

If we also include a WACC of 7.45%, the implied NPV of future FCF would be $1.098 billion. Besides, with an EV/EBITDA ratio of 12.95x, the terminal value would stand at $2.50 billion together with a NPV $1.13 billion. The enterprise value would be $2.235 billion, equity would stand at $1.533 billion, and the fair price would be $73.7 per share with an IRR of -3.47%.

My Takeaway

EnPro offers a significant number of products to many large clients in very different industries and countries, which, in my view, will likely make the revenue line very stable. Management also intends to divest and acquire other companies to refocus on activities that bring higher EBITDA margins and recurrent revenue. In line with this, I would expect new acquisitions like that of NxEdge. There are clearly many risks, including failure to offer differential technological value, inflationary raw material costs, and changing regulations. However, I believe that the company, right now, trades at an undervalued price.

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