MOD - Modine Manufacturing: The Risks Outweigh The Rewards

Summary

• Today I'd like to talk to you about a small company, perhaps a relatively unknown company, but a piece of American history nonetheless.
• However, as with any company, Modine is not without its challenges and risks. Increased competition, high customer concentration, and lackluster financial performance are just a few of the issues.
• Even after COVID has begun to reside, we still find that earnings per share are still below what it was at the start of the millennia.
• In fairness, COVID was a hard year, but even further back Modine was only generating low single-digit returns on capital.
• When I can get a risk-free return of 4%+ from treasuries, why would I let Modine invest any money for me?

Introduction

Today I'd like to talk to you about a small company, perhaps a relatively unknown company, but a piece of American history nonetheless. Today, I'd like to talk to you about Modine Manufacturing ( MOD )...

However, as with any company, Modine is not without its challenges and risks. Increased competition, high customer concentration, and lackluster financial performance are just a few of the issues that must be considered when looking at this business.

In this article, we will take a closer look at Modine's history, business segments, and financials to gain a deeper understanding of what this company has to offer. By exploring both the positives and negatives, I hope to provide a well-rounded analysis of Modine Manufacturing and offer some insights into what investors can expect from this fascinating piece of American history.

From Tractors to Fighter Planes: The Journey of Modine Manufacturing

Modine Manufacturing is a premier thermal management company with a rich history dating back to 1916. Despite the challenges posed by declining manufacturing in the US, Modine has remained a leading player in the industry. The company was founded by Arthur B Modine, who patented the innovative Spirex radiator for tractors. This creative thinking was evident from the beginning, as Modine quickly rose to prominence by manufacturing the Turbotube radiator for Ford Model T cars.

In 1941, Modine made a significant impact on the automotive industry by building the world's first vehicular wind tunnel in Racine, Wisconsin. This further solidified the company's position as a leader in thermal management technology. During WWII, Modine played a crucial role by manufacturing aftercoolers for the P-51 Mustang fighter plane, demonstrating the company's ability to adapt and deliver in challenging times.

Despite the declining state of manufacturing in the US, Modine has remained a strong player in the market by staying ahead of the curve with innovative products and a commitment to excellence. The company has successfully navigated the challenges posed by declining manufacturing in the US and continues to thrive as a result, recently nearing its all-time high in sales.

They operate in two primary segments, Climate Solutions, and Performance Technologies, with the latter focusing on the electric vehicle market. Recently the company has shifted its focus to concentrate on the EV market and its EV-focused sub-businesses are experiencing above-average growth, making Modine more and more an EV-centric company as a result.

Risks

But not all is great for Modine, they are also subject to a number of risks...

The growing demand for heat transfer systems has led to an influx of competitors investing in new and innovative products. This increase in competition could make it difficult for Modine to differentiate its offerings, leading to a decline in market share and profitability.

Furthermore, a recession in the industry could intensify the effects of increased competition and harm Modine's financial performance. During a recession, many companies are less likely to invest in research and development and large projects, which can exacerbate the effects of increased competition hurting margins that are already quite low.

High customer concentration is another concerning issue for Modine. Nearly 39% of the company's total revenue comes from its top five customers, making it highly reliant on a small number of large customers. This concentration puts them at risk, as fluctuations in margins could result from pressure from these large customers. Moreover, high customer concentration limits the company's pricing power, which could result in lower profits over time.

Financials

Starting with revenues we can see that Modine has grown relatively in line with the other small-cap manufacturing peers. Over the past decade, they have grown their revenues by just under 60%.

We can also see that revenue growth has been accelerating which is quite a positive development. Historically, the company has struggled to maintain long periods of growth so this will remain an important metric for investors to track going forward.

Moving on to EPS growth and things appear to be a bit choppy... Clearly, Covid was a challenging time for the company, dropping earnings sharply into the negative territory as factories shut down worldwide. But even after Covid has begun to reside we still find that earnings per share are still below what it was at the start of the millennia.

Based on the chart above, clearly, Modine's operating margins are nothing to write home either standing at just under 6%. The silver lining to this is that their margins appear to be expanding while some of the other companies are declining.

Unfortunately, this is where the hypothetical bull thesis begins to take a sharp turn for the worse. Judging by their average return on invested capital all of these companies, save Standard Motor Products ( SMP ) appear to be exceptionally poor capital allocators. American Axle ( AXL ), Stoneridge ( SRI ), and yes, sadly Modine too have all yielded close to a 0% return on capital over the past 3 years. In fairness, COVID was a hard year, but even further back Modine was only generating low single-digit returns on capital. When I can get a risk-free return of 4%+ from treasuries why would I let Modine invest any money for me?

To Sum It All Up

In conclusion, Modine Manufacturing is a company with a rich history in thermal management, but despite its past successes, the current state of the company leaves much to be desired for potential investors.

The growth in competition in the industry has made it increasingly difficult for Modine to differentiate its products and maintain market share, putting its profitability at risk. The company's high customer concentration also limits its pricing power and leaves it vulnerable to fluctuations in margins from its top five customers.

On the financial front, Modine's revenues have grown relatively in line with its peers, but its earnings per share have been choppy and below historical levels. Additionally, the company's operating margins, while expanding, are still underwhelming at just 6%.

The most concerning aspect of Modine's financials is its poor capital allocation, evidenced by its near 0% return on invested capital over the past three years.

Given the options for a risk-free return in treasuries and the current state of Modine's financials, it is hard to recommend this company as a worthwhile investment. Shares look extended at these levels.

For all of those reasons, I rate Modine a Sell.

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