NPO - Enpro: Transitioning After A Tougher Year

2024-01-03 06:42:19 ET

Summary

• Enpro has undergone a continued and successful transformation, resulting in a more balanced and higher margin business.
• The company's transition to long-term growth areas has impacted its operating performance, leading to a cautious view.
• Enpro has announced a deal to acquire Advanced Micro Instruments, furthering its strategic transformation and bolstering its advanced surface technologies segment.

In the fall of 2022, I believed that Enpro Inc. ( NPO ) was seeing a successful transformation, as its practice of buying and selling of assets at the same time created a much more balanced, focused and higher-margin business.

Liking the moves made by management, I was warming up to the business, holding a true long term view, as shares have risen some 70% since that point in time, trading near their highs here. This has come amidst the continued transition of the business, but ironically it was this transition to long term growth areas which hurt the operating performance last year, as these end markets have seen a tougher 2023.

Given the softer operating performance and runaway share price performance, I am taking a more cautious view here, as Enpro announced its latest deal in its continued transition.

Creating Some Perspective

Enpro provides highly engineered solutions for so-called mission-critical applications in the field of chemicals, automotive, aerospace, laboratory solutions and chip manufacturing. Pre-pandemic, the company generated $1.2 billion in sales, three quarters of which was generated from sealing products and the remainder coming from engineered products.

Two-thirds of sales were generated in the US, with revenues split pretty evenly between OEM sales and aftermarket supplies. In terms of segments, the company relied on a $900 million sealing business, with revenues generated from oil seals, performance seals and suspension components. Engineered solutions was a $300 million business, focused on energy transition, aerospace and semiconductor applications.

With a $1.2 billion revenue base pre-pandemic, the company posted adjusted EBITDA of $169 million, and adjusted earnings of just $56 million, equal to $2.68 per share. GAAP earnings were largely non-existing following a myriad of charges, with shares trading in the $60s, as the company aimed to grow margins and become a more diversified and growth oriented business.

Many Changes Take Place

Since the start of the pandemic, many moving factors have taken place at the business. This included a $450 million sale of Fairbanks Morse, which took place early in 2020, followed by a $255 million purchase of Alluxa later that year, through which the company added optical filters and thin film coatings to the product line-up.

Through September 2022 shares had risen to the $90 mark as underlying advancements were seen in the meantime. While 2020 sales fell 11% to $1.07 billion, adjusted earnings improved to over $4 per share, with net debt coming down.

The company furthermore sold its Compressor Products business in a $195 million deal in 2021, with money used to acquire NxEdge in a $850 million deal, adding manufacturing, cleaning, coating and refurbishment businesses within the semiconductor sector.

Early in 2022, the company reported a 6% increase in 2021 sales to $1.14 billion, with adjusted earnings of $5.55 per share coming in a dollar ahead of the original guidance for the year. Furthermore, more growth was seen in 2022 with sales growth seen in the low double digits, and earnings seen around $7 per share. Net debt of $769 million worked down to a near 3 times leverage ratio, while the positioning of the business has become a lot more balanced between its segments.

Trading at $90, the company traded at a rather compelling earnings multiple, as the company furthermore announced a $305 million sale of the engineering activities to Timken Company. Given all these moving parts, I pegged earnings power around $6 per share in September 2022, with net debt seen around 2 times EBITDA following the latest divestment, while the positioning has improved a great deal.

Moving Up

Unfortunately, I did not follow up on my own advice as a $90 stock in September 2022 broke the $100 mark later that year, after which shares consolidated around those levels in the first half of 2023, having risen to $156 per share here, trading near their highs.

Early in 2023 the company posted its 2022 results, and they were complicated. As a result of divestments, reported revenues for the year came in at $1.10 billion, actually down from 2022. The business became a lot better and more profitable, with adjusted EBITDA margins improving more than four points to 23% and change. This resulted in adjusted EBITDA posted at $257 million, and adjusted earnings coming in at $7.04 per share.

With divestments still impacting the business, the company guided for 2023 sales to come in flat, or grow by low single digits. EBITDA was seen at a midpoint of $254 million, with adjusted earnings seen between $6.45 and $7.05 per share, all while net debt has come down to $456 million.

After a posting a solid 6% increase in first quarter organic sales, the company maintained the full year outlook, as the guidance was more or less reiterated after second quarter organic growth rates came in around the flat line. Third quarter results were rather disappointing, at least on the headline, with organic sales down 10% and change.

Nonetheless, the company more or less reiterated the guidance, with full year sales seen flattish, with both earnings and adjusted earnings coming in at the lower end of the range, respectively $6.70-$7.10 per share and $248-$256 million. Promising is that net debt has come down to $318 million, pushing leverage ratios down a great deal.

The irony is that the current decline is actually the result of softer market conditions in the Advanced Surface Technologies segments, due to exposure to the semiconductor sector, as acquisitions in this area were designed to offset weakness in Sealing Technologies, which actually has been performing quite well.

With 21 million shares trading around $156, the company commanded a near $3.3 billion equity valuation, of $3.6 billion enterprise valuation, valuing operations at around 3.5 times sales and a full earnings multiple at 22–23 times adjusted earnings, with leverage down quite a bit.

Another Moving Part - Another Deal

On top of the mixed performance year to date, which actually went hand-in-hand with a rising stock price, it was Enpro which announced a substantial deal towards the end of the year. The company has reached a $210 million deal to acquire Advanced Micro Instruments, a provider of highly engineered analyzer and sensing technologies. These are generally used for clean energy transition purposes, valued at 13 times EBITDA.

The deal is equal to about 6% of the enterprise valuation and is regarded as a bolt-on deal, perhaps a bit more, adding to the strategic transformation of the business, in an effort to bolster the share of advanced surface technologies to 50%. Pro forma net debt of $549 million is very manageable, at around 2 times EBITDA.

And Now?

The reality is that while I greatly applauded the transition back in 2022, ironically it was the transition which hurt the business, with the semiconductor declines hurting the overall results. Nonetheless, the business is a lot better positioned and its earnings trend at $6 despite the current shortfall in the business.

Amidst all of this, I am a bit cautious here. While the business has seen a solid transition, shares have performed well in 2023, while the results have been lagging. It is this combination, which pushed up expectations a lot, which makes shares look less compelling in my book.

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