GRC - The Gorman-Rupp Company: Fantastic Quarter Creates Favorable Risk-Reward Scenario

2023-08-28 10:08:05 ET

Summary

• The Gorman-Rupp Company beat EPS estimates for the last quarter, showing its ability to grow despite macro headwinds.
• GRC's strategy of expanding into new markets through acquisitions allows it to tap into a variety of sectors and mitigate risk.
• The company's strong financial performance, including increased net sales and adjusted EBITDA, suggests potential for stronger dividends and share price growth.

Investment Rundown

There hasn't been any lack of growth on the side of The Gorman-Rupp Company ( GRC ) recently as the company beat out strongly on EPS estimates for their last quarter. The company showcased to investors that despite ongoing macro headwinds they are very much able to grow still. The question arises of how much the company can rise once headwinds like high interest rates start to fade. In my opinion, a lot, which creates the favorable risk rewards scenario I see that the company having right now.

GRC is included in the industrial sector where it has grown steadily to a market cap just shy of $900 million. Growth drivers going forward will be the company's aggressive nature in growing its market share and establishing itself in new markets. This together with shareholder-friendly practices like a dividend yield makes me prone to rate the company a buy right now.

Company Segments

Operations in GRC is just a singular segment, which involves the manufacturing and sale of pumps and pump systems. GRC’s strategy for diversification is notable not because of the number of operating segments, but due to the array of end markets it serves. This strategic breadth enables GRC to mitigate risk by tapping into a multitude of sectors, each with its own unique demand drivers and market dynamics. The expansion into new markets primarily comes from acquisitions which the company engages in.

The most recent acquisition by the company was last year in late April with the acquisition of Fill-Rite. The purchase lent GRC the ability to tap into a variety of other industries and markets too as Fill-Rite holds a diversified set of end markets. It is the number one brand in the fuel transfer pump industry and has managed to gather up a network of over 2,000 different partners.

They are expanding capacity for the business this year as their other two operations sites are located in Indiana and Kansas. We likely won't see the impact until at least next year, but seeing GRC optimistic about expansion and willing to do it tells me they view it positively in the coming years despite short-term headwinds.

GRC has grown its business from strategic M&A which has led to them being where they are today. The last report showcases the company's ability to grow rapidly despite facing challenges. For instance, the net sales came in at $171 million which was an increase of 43% YoY. Seeing that type of momentum in the industrial sector is not often you come across. For the bottom line, the EPS came in at $0.41, and adjusted EBITDA grew 71% YoY. This showcased GRC's ability to grow margins very quickly and I think we should be seeing stronger dividends ahead. The yield still sits strong at 2%. An introduction of a buyback program would most likely help make the share price increase further.

Risks

The primary concern with investing in GRC is tied to economic factors right now, something the company doesn't necessarily have any power over at all. Historically, the company has experienced vulnerability to economic downturns, which in turn have negatively impacted its financial performance and consequently its stock performance as well. These are short to medium-term headwinds more than anything else and for investors that seek additions for the long-term then they shouldn't be too concerned about this. A drop in the share price might just open up another opportunity to add more.

For instance, a noteworthy decline in economic conditions triggered a substantial drop in sales from $436 million in 2014 to $406 million in 2015. This drop in sales was largely caused by the downturn in the construction market, which was further accelerated and inflated by a significant decline in oil and gas drilling activities both within domestic and international spheres. However, since then the company has done very well for itself and continues to chug along. But I don’t think it's sufficient enough to make for a hold rating here. The company showcased in the last report that demand is still strong and that we are seemingly hitting a bottom of sorts here.

Financials

Strong strides have been made on the balance sheet for the company but there are still some improvements I’d like to see be made before I could justifiably say they boast a strong financial position.

Why I am saying this is because of the long-term debts still sitting quite high at $411 million. Since the last of December 2022, it has been decreasing though, which is a step in the right direction for sure. However, it is still not impacted enough by the cash position if GRC were to deploy all of it as it's just $12 million.

Comparing the net debt to the EBITDA we get a ratio of about 4 which is a fair bit above 2.5 - 3 which is where most people would consider the threshold to be for a sound leverage ratio I think. GRC still operates as a growing company as we can see from the last results so being slightly higher on this scale isn't necessarily that bad in my opinion. Going into the coming quarters what could justify a higher p/b would be if GRC places a focus on building up the cash position and also actively reducing the debts even faster.

Final Words

As I have made clear throughout the article is the fact that GRC had a solid last quarter and seems to be operating as a high-growth company right now. EBITDA margins grew at a solid rate YoY and I think both Q3 and Q4 could showcase similar trends. In terms of valuation, right now for GRC, I think is appealing as the company has been performing very well and deserves some premiums on certain metrics. The P/E for example, is at a premium of 36% to the sector. But as GRC is able to quickly grow its top lien and one's interest rates go down, then I think EPS growth will follow. The P/S metric of the company is at a near 10% discount and I think this really constitutes a buy for me. Even if the P/S is at 1.35, which is the same as the sector, I think GRC is a buy based on the fundamentals and market position they have currently

The valuation of the company is perhaps at a premium compared to the sector, but as the last few years proved to be difficult, a rebound like this makes the valuation seem reasonable as the EPS continues to grow swiftly. Paying 26x earnings for the company right now seems fair as they are still growing rapidly and able to distribute a very solid 2% yield dividend for investors. I like where the company is heading and will be rating them a buy.

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