GRC - The Gorman-Rupp Company: Primed For Growth

2023-05-18 15:30:00 ET

Summary

• GRC should benefit from a healthy order backlog and the acquisition of Fill-Rate in the near term.
• In the long run, the company should benefit from infrastructure spending in the U.S. and internationally.
• Based on my DCF calculation and relative valuation, I have a buy rating on the stock.

About the Company

The Gorman-Rupp Company ( GRC ) designs, manufactures, and sells pumps and pump systems for use in various applications. The company's end markets include wastewater, construction, dewatering, industrial, petroleum, original equipment, agriculture, fire suppression, HVAC, and military. On May 2022, GRC acquired Fill-Rite for $528 million, which was funded by cash on hand and new debt. Fill-Rite is a leading provider of fixed and portable fuel transfer pumps, chemical transfer pumps, meters, and accessories.

Q1 FY23 Financial Performance Overview

Recently, GRC reported its first quarter FY23 financial result, which was better than expected. The revenue in the quarter increased by 57.1% Y/Y to $160.47 million, which is above the consensus estimate of $157.38 million. The revenue growth in the quarter was due to the acquisition of Fill-Rite in May 2022 and healthy demand in its end markets, including water infrastructure, petroleum, and industrial. Organic sales in the water markets increased by 20.1% Y/Y and 12.8% in the non-water markets.

The adjusted EPS declined by 7% Y/Y to $0.27, which is above the consensus estimate of $0.20. The gross margin in the quarter improved by 340 bps Y/Y to 28.4%, and the adjusted EBITDA margin improved by 370 bps Y/Y to 17.7%. The improvement in margins was due to increased sales volume, an improvement in material costs, and the acquisition of Fill-Rite. Despite this improvement, the adjusted EPS declined due to the increased interest expense related to the acquisition.

Outlook

Looking forward, I believe revenue growth should be driven by a strong order rate and a healthy order backlog. Incoming orders continued at a good pace in Q1 FY23, with total incoming orders during the quarter of $167.0 million, a 49.1% Y/Y increase. The order backlog for the quarter also experienced a significant boost, soaring by 38.4% year-on-year to reach $270.6 million. This growth can be attributed to both the heightened order rate and the recent acquisition of Fill-Rite. To effectively support this strong order backlog, GRC made strategic adjustments by increasing its inventory levels. Consequently, inventory surged by 30% year-on-year to $116.7 million during the quarter.

Beyond a robust order backlog, GRC is poised to benefit from emerging trends in its end markets, which are expected to stimulate demand for its products and subsequently drive revenue growth. The 2021 infrastructure report card for the United States, specifically in the areas of drinking water, wastewater, and stormwater infrastructure, highlights the urgent need for improvements. With grades ranging from C- to D, it is evident that the water-related infrastructure in the country is aging. Fortunately, under the Infrastructure Investment and Jobs Act (IIJA) funding, approximately $55 billion has been allocated to enhance clean drinking water, wastewater, and stormwater infrastructure. This presents a significant opportunity for GRC to capitalize on these investments.

Moreover, GRC's international business accounts for approximately 27% of its revenue. Considering the escalating global population, rapid urbanization, and growing demand for safe drinking water in developing nations, governments in these countries have outlined comprehensive infrastructure programs. These initiatives are expected to further bolster GRC's prospects in the medium to long term.

Overall, GRC's revenue growth is set to benefit from multiple factors, including its robust order backlog, the acquisition of Fill-Rite, and substantial infrastructure spending in the United States and internationally. By capitalizing on these opportunities and leveraging its strategic position, GRC is poised for continued success in expanding its revenue.

Valuation

In my DCF calculations, I am assuming revenue growth to be in the double digits in 2023, given the acquisition of Fill-Rate and a healthy order backlog. Beyond 2023, I have assumed growth to be in the high-single digits, with a terminal growth rate in the mid-single digits, as the company will continue to benefit from water infrastructure investments in the United States and internationally. I used a discount rate of 6.54% and arrived at a fair value of $29.73 for GRC.

Using the relative valuation, if we use a consensus EPS estimate of $1.06 for 2023, we get a price-to-earnings ratio of 23.08x, and if we use a consensus EPS estimate of $1.53 for 2024, we get a price-to-earnings ratio of 15.99x. These values are well below the five-year average forward P/E of 25.05x. Taking the FY24 EPS estimate and the average forward P/E, we arrive at a fair value of $38.32 for GRC. Hence, I have a price target range of $29 to $39 for the company.

Conclusion

In conclusion, I have a buy rating on the stock. GRC exhibits promising prospects for revenue growth, supported by a healthy order backlog, the acquisition of Fill-Rite, and infrastructure spending in both the United States and international markets. The company's strong order rate and increased inventory levels indicate a favorable near-term revenue outlook.

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