MLI - The Timken Company: Fundamentals Give A Reason To Remain Bullish

2023-04-19 17:37:00 ET

Summary

• The Timken Company continues to fare well from both a fundamental perspective and a share price perspective.
• The stock can only rise so high, but even with the move up that has been seen, it's likely that shares can move higher.
• In all, the company is an appealing prospect in the current environment, and management also expects performance to continue this year.

Given the state of the economy, I can understand why investors would be cautious about many different types of companies in many different types of industries. One area that you would think would be at risk is anything related to the industrial supply space. This would be especially true when it comes to companies that are engaged in the production of things such as engineered bearings and power transmission products. Be that as it may, one company that does exactly this kind of stuff that has done quite well for itself and its shareholders is The Timken Company (TKR). Even recently, sales data and profit data for the company have been incredibly attractive. On top of this, shares of the business look cheap, both on an absolute basis and relative to similar firms, even in spite of its share price moving materially higher. Although I do think that the easy money has already been made by this point, I do think that the fundamentals are indicative of a company that offers further upside from here.

A great picture so far

Times have been really great for The Timken Company and its investors. When I last wrote about the company in an article published in early September of last year, I recognized how well the company had done in what was then the current environment. Sales were rising, and profits, while mixed, were still looking positive. Leading up to that point, shares of the business had risen nicely. But because of how cheap the stock still was, I had no choice but to rate it a 'buy' to reflect my view at the time that it should outperform the broader market for the foreseeable future. And so far, that's exactly what the company has done. While the S&P 500 is up 5.6% since I last wrote about the firm, its shares have generated upside of 23.7%.

Given this massive return disparity, you might think that further upside from this point would be unlikely. However, I do think that it is very possible. For starters, The Timken Company is a sizable and vibrant enterprise that has continued to post impressive results as of late. To see what I mean, we need to only look at data covering the 2022 fiscal year . Sales for that time came in at just under $4.50 billion. That's 8.8% higher than the $4.13 billion in revenue generated one year earlier. Sales growth would have been higher had it not been for $142 million of impact that the company saw as a result of foreign currency fluctuations. Actual organic growth achieved by the company was a robust $478 million that management attributed to a mixture of higher demand across both of its operating segments (which will be reorganized when the company announces first quarter earnings release for 2023), and higher pricing aimed at combating inflationary pressures. Acquisitions and divestitures, on a net basis, helped the company as well, but only to the tune of $28 million.

Bottom line results for the company showed continued promise as well. Net income jumped from $369.1 million in 2021 to $407.4 million last year. Operating cash flow showed a similar trajectory, rising from $387.3 million to $463.8 million. If we adjust for changes in working capital, it would have risen from $542.9 million to $634.5 million. And finally, EBITDA for the company expanded from $718 million to $855.9 million. For those worried about whether market conditions are deteriorating or not, it would be wise to look at the chart above, which shows data for the final quarter of 2022 relative to the same time one year earlier. Without exception, the company's top and bottom line performance figures came in stronger in 2022 than the year prior.

More likely than not, the picture for the company will continue to improve this year. Management is forecasting revenue growth of 6% for 2023. Higher pricing, as well as strong demand, should help the company tremendously. But there's no doubt that the aforementioned acquisitions will help the company as well. It is true that the contribution from acquisitions was fairly small last year, but that largely relates to the timing of the acquisitions. You see, for 2022 as a whole, management allocated, net of cash received, $453.7 million toward buying up other businesses. $301.3 million of this occurred in the final quarter of the year.

On November 4th of last year, for instance, the company's acquisition of GGB Bearing Technology was completed. That alone should bring about $200 million worth of sales per annum to the company. Acquisition activity continued into the current fiscal year. On April 4th, for instance, management said that they completed their acquisition of Nadella Group, a European producer of linear guides, telescopic rails, actuators, and other industrial offerings. Using current exchange rates, that particular deal should bring around $109 million in additional revenue to the company. While making these acquisitions, management has also been able to successfully buy back stock and pay distributions. In fact, they allocated $91.7 million toward dividends, with another $211.6 million dedicated to buying stock and classifying it as treasury shares. This all worked out to about 4% of the company's shares outstanding.

On the bottom line, management expects earnings per share of between $5.80 and $6.40 for the year. On an adjusted basis, earnings should be between $6.50 and $7.10. At the midpoint, this should translate to net income of roughly $500.3 million. Sadly, no guidance was given when it came to other profitability metrics. But if they grow at the same rate that earnings should, then we should anticipate adjusted operating cash flow of $779.2 million and EBITDA of $1.05 billion.

Based on these figures, I was able to value the company, as shown in the chart above. That chart also covers valuation data using results from 2021 and 2022. As part of my analysis, I also compared the company to five similar enterprises, which can be seen in the table below. With a price-to-earnings multiple of 13.9, a price to adjusted operating cash flow multiple of 8.9, and an EV to EBITDA multiple of 8.6, The Timken Company ended up being cheaper than all but one of the five firms I compared it to.

Takeaway

Operationally speaking, The Timken Company seems to be in really good shape. Management continues to achieve positive revenue, profit, and cash flow results. On an absolute basis and relative to similar firms, shares of the company look cheap. Even while focusing on growth, both organically and by means of acquisition, management is successfully allocating capital toward buying back stock and paying distributions. All of these, to me, seemed to be a recipe for success. And because of that, I decided to keep the 'buy' rating I had on the stock previously.

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