NPO - EnPro: Q2 Performance Sealing The Gaps And Soaring Ahead

2023-08-11 09:00:00 ET

Summary

• EnPro Industries reported better-than-expected financial results, with a non-GAAP EPS of $1.83 and revenue of $276.9M.
• The Sealing Technologies division showed strong sales growth of over 13%, driven by demand in aerospace, nuclear, and commercial vehicle sectors.
• Despite some risks, EnPro's financial strength, strategic growth initiatives, and positive stock performance make it a promising investment opportunity.

Thesis

In the recent Q2 financials of EnPro Industries ( NPO ), the company reported a non-GAAP EPS of $1.83, which beats expectations by $0.09, and a revenue of $276.9M, surpassing projections by $0.47M. An analytical dive into these results reveals a balance in sector performance, particularly with strong showings in aerospace, nuclear, and commercial vehicle sectors offsetting the weaknesses in the semiconductor segment. Particularly noteworthy is the Sealing Technologies division's sales growth of over 13%. This analysis argues that despite some risks, such as the decline in adjusted EBITDA and impairment charges, EnPro's financial strength, strategic growth initiatives, and positive stock performance position it as a promising investment opportunity.

Company Overview

EnPro Industries, Inc., based in Charlotte, North Carolina and established in 2002, operates primarily within two sectors: Sealing Technologies and Advanced Surface Technologies. The Sealing Technologies division delivers a range of products from single-use hygienic seals to custom-engineered mechanical seals for industries such as power generation, aerospace, and chemical processing. Meanwhile, the Advanced Surface Technologies division offers services like cleaning and coating, especially tailored for the semiconductor, space, and defense sectors, and supplies specialized optical filters for diverse markets, including industrial technology and life sciences.

EnPro Industries' Q2 Earnings Highlights

In a recent analysis of EnPro Industries' performance, several notable financial and strategic shifts emerge within the company's Q2 data. The company's Q2 sales remained consistent, standing at $276.9 million year-over-year. What's interesting to observe is the mild growth in organic sales, which effectively counteracted the drawbacks induced by the semiconductor sector's softness .

The Sealing Technologies division, which reported sales of $176.7 million - a growth of over 13% - can be credited to a combination of factors: heightened demand across aerospace, nuclear energy, and commercial vehicle sectors, along with effective volume growth, and a combination of operational efficiency with well-calibrated pricing strategies.

Diving deeper into the nuclear market specifics, EnPro's CFO, Milton Childress, highlighted that there appears to be no alteration in the broader outlook for EnPro's nuclear shipments; though Childress did point out that the first half of the year tends to show stronger shipment figures in comparison to the latter half. This might be attributed to the sequence and timing of orders.

Turning to the company's financial health, the balance sheet indicates solidity. By the close of this quarter, the net leverage ratio stood at 1.5x. Additionally, a considerable term loan was settled using the available cash reserves, reflecting the firm's significant financial agility and long-term growth ambition. When asked about future financial management strategies, Childress mentioned a maturity date of 2026 for the residual term debt. Presently, EnPro seems more inclined towards investment-led growth, constantly re-evaluating the potential of capital-intensive business support and scouting for strategic external opportunities.

Furthermore, during the first half of 2023, the company recorded a free cash flow of over $66 million, an uptick from last year's $56 million. Such figures not only underscore the company's relatively strong cash generation capability but also its potential to back upcoming growth and efficiency initiatives. Moreover, EnPro's dividend payments reiterate the firm's dedication to its shareholders.

Lastly, the 2023 projections anticipate the company's revenue to maintain a parallel trajectory as the previous year. The adjusted EBITDA is forecasted to settle between $248 million and $256 million. The slight wane at the EBITDA's upper limit can be attributed to the $4 million incentive expense linked to the share price. However, buoyed by the early repayment of a section of their long-standing debt and augmented interest yields on cash reserves, they're optimizing the adjusted diluted EPS guidance to fall between $6.70 and $7.10.

Performance

Normally, I focus on the medium-term with respect to share price performance, but with EnPro, I opted to look at a shorter-time frame since the spring of 2020 appears to be a key, positive turning point for the company based on its performance.

Starting with a beginning price of USD 67.64 in January 2020 to USD 126.01 in August 2023, investors witnessed an appreciation of around 86%. This is more than impressive, especially when benchmarked against the S&P 500's growth of 11.03% over the same period. The compound annual growth rate of 19.89% versus 11.03% illustrates EnPro's superior return to shareholders. The growth in dividends per share has also been consistent, with an average of 3.85% over three years.

Valuation

EnPro's blended P/E ratio of 18.04x (see chart below) is slightly below the normal P/E ratio of 19.70x, which typically signals a potential undervaluation. Also, the adjusted operating earnings growth rate of 18.17% stands out and appears healthy; and in my opinion, this is a positive sign for investors, as it might imply a solid growth trajectory. Combined with a P/E=G ratio of 18.17x, the numbers are consistent and demonstrate decent growth prospects.

Risks & Headwinds

The adjusted EBITDA in the quarter was $64.9 million, marking an 11.9% decline over the corresponding period of the preceding year. The EBITDA margins likewise fell, slipping from 26.6% to 23.4%.

Also, corporate expenses for the quarter rose from $9.4 million a year ago to $15 million, primarily driven by share price-related incentives and amplified compensation expenses.

The response to these developments by CFO Childress outlines a phased modulation in the company's long-term incentive compensation plan. Over the next 18 months, the company will transition the relative TSR incentive component from cash to shares. By the time the 2023 plan takes effect, this change should counterbalance the expense fluctuation tied to share price changes, thereby improving the company's fiscal position.

The Advanced Surface Technologies division offers further insight. Second-quarter sales there reached $100.3 million, but this figure marked a 17.4% decrease, primarily traceable to a slowdown in semiconductor markets mentioned earlier. The adjusted segment EBITDA tumbled by 36.2%, a development which mirrors a decline in volume and an unfavorable mix.

Alongside this, the quarter brought with it a non-cash impairment charge of $60.8 million against Alluxa's goodwill. This was instigated by results falling short of projections. Nevertheless, management has provided assurances to investors. The business, they claim, continues to rest on strong foundations, with anticipations of high single-digit organic growth over a multiyear period and adjusted EBITDA margins that comfortably exceed both AST segment and total company averages.

Final Takeaway

Based on the provided information, I would rate EnPro Industries' stock as a "buy." The company shows impressive resilience through well-balanced sectors, and its Sealing Technologies division has demonstrated strong growth. The consistent sales, strength in aerospace, nuclear, and commercial vehicle segments, improved free cash flow, and the stock's recent short-term appreciation all suggest a positive outlook. There are risks such as a decline in adjusted EBITDA and an impairment charge, but overall the company's financial solidity, strategic growth focus, and management's assurances about future performance paint an encouraging picture.

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