FELE - Franklin Electric: Pumping Profits

2023-07-26 20:02:32 ET

Summary

• Franklin Electric Co., Inc. has seen a rather stagnant share price while earnings power has improved meaningfully.
• After a somewhat underwhelming guidance for 2023 at first, the company has upped the guidance in a modest fashion.
• Multiples are rapidly coming down, which is appealing given the balance sheet strength and lower leverage situation.
• While appeal is increasing, the valuation is still a little too high to pull the trigger here after a non-inspiring second quarter.

At the start of 2022, I believed that shares of Franklin Electric Co., Inc. ( FELE ) were electrified by the water. The company had made some bolt-on deals at the time, improving its positioning as shares have rightfully gained significant ground.

Calling the valuation fair to rich early in 2022, Franklin was an interesting play which has rapidly built up a solid track record, and investors have subsequently having priced in the positioning a bit too much if you ask me.

Over the past eighteen months, shares have been trading flat while the business has seen a solid operating performance, with earnings per share up 40%, reducing valuation multiples quite a bit. This means that appeal is increasing a lot, not enough yet for me to get involved just yet.

A Recap

In the early 2000s, Franklin was still a pure play on motors and controls, as the company has continuously transitioned the portfolio, into groundwater, water systems, dewatering and industrial applications, creating a decent ESG play.

Pre-pandemic, the company was a $1.3 billion business in 2018/2019, posting profits around $2 per share, with shares trading at around the $60 mark pre-pandemic. These were demanding valuations at 30 times earnings, although that the company guided for 2020 earnings to come in around $2.30 per share.

While the 2020 performance came in a bit softer, for obvious reasons, the company guided for continued growth in 2021, while announcing some bolt-on deals along the way. The business was on track to generate about $1.7 billion in annual sales based on the third quarter results in 2021, with earnings set to come in around $3 per share based on an EBITDA number of a quarter of a billion.

With shares trading at $95, the 47 million shares valued equity at $4.5 billion, a valuation which increased in a modest fashion if a $121 million net debt load is included, as the valuation had risen to 30 times earnings. Early in 2022, Franklin announced another bolt-on deal, acquiring Blake Group Holdings in a $27 million deal, adding $74 million in annual sales, and while this bolt-on deal looked interesting, the overall valuations were too demanding for me to get upbeat on the shares.

Trading Stagnant

Amidst tougher times, shares of Franklin Electric fell to the $80 mark in the summer of 2022, driven by higher interest rates and concerns on growth and margins. Shares recovered and broke the $100 mark last month, and after hitting a high at $107 per share they now trade at $98 per share.

Soon after laying down the thesis above, Franklin Electric posted its 2021 results in February, which included a 2022 outlook in which sales were originally seen between $1.90 and $2.05 billion. Earnings were between $3.50 and $3.75 per share, as the company was prepared for another year of strong growth.

In February of this year, it became apparent that the company had seen strong growth, with full-year sales up 23% to $2.04 billion, as revenues came in at the higher end of the guidance. Operating earnings rose as much as 35% to $257 million, pushing up margins further as diluted earnings rose to as much as $3.97 per share, for earnings of $4.00 per share if we adjust for restructuring charges. Net debt has come down to $170 million, for a leverage ratio of around 0.5 times EBITDA.

For 2023, the company guided for mere modest advancements in the results, with sales seen between $2.1 and $2.2 billion, and earnings seen between $4.10 and $4.30 per share.

In May, the company posted strong first quarter results, with sales up 7% to $485 million as earnings of $0.79 per share came in sixteen cents ahead of last year. The company hiked the midpoint of the sales guidance by fifty million to $2.2 billion, with earnings now seen at a midpoint of $4.35 per share.

Late in July, Franklin posted resilient second quarter results as well even as revenue growth slowed down to 3%, with sales in the seasonally strong quarter being reported at $569 million as earnings improved by a penny to $1.27 per share. The company maintained the full year guidance as net debt ticked up to $194 million, mostly due to some share buybacks.

And Now?

With Franklin Electric Co., Inc. trading at $98 per share, a low thirty times earnings multiple early in 2022 has compressed to 23 times earnings as shares have been trading stagnant and earnings power has improved meaningfully. For the second quarter, about 55% of sales are tied to water systems, the fastest grower of the business and the driver behind the premium multiple. Distribution, which is responsible for about a third of sales, was resilient as well. The smaller fuel systems, which has a somewhat more challenged positioning, has seen some revenue declines.

The company remains really well positioned, as nearly 30 percent of the business is tied to groundwater systems, which is a driver for the business given the greater occurrence of heatwaves and droughts, but limitations on the usage of ground water of time could become a headwind over time as well. Water treatments solutions, greywater, large dewatering, wells and other services make up for the remainder of the business, alongside the fuel systems.

Given the situation described above, in which a well positioned business has seen significant earnings improvements over the past eighteen months, while shares have been trading flat, the appeal of Franklin Electric Co., Inc. is increasing. That said, even for a largely under leveraged business, a current 23 times multiple remains on the demanding side given where interest rates are.

Given all this I see appeal increasing a lot, just not enough to get involved here, although that I am looking to enter Franklin Electric Co., Inc. if dips might arise and sent shares to the $80s.

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