TWIN - Twin Disc: Finally Gaining Some Momentum

2023-03-07 16:12:07 ET

Summary

• Company meets earnings estimate in Q2 on stronger demand.
• Better trading conditions are expected to lead to a significant contraction  in Twin's inventory levels.
• Keen valuation and improving momentum could lead to a sustained rally in the share-price here.

Intro

We wrote about Twin Disc Incorporated ( TWIN ) back in December of last year post the company's first quarter numbers when we stated that margin growth was a real priority at the firm. Trading conditions were resulting in elevated inventory levels and inflation was running riot on the company's purchasing costs. Considering that Twin Disc and this industry, in general, has high fixed costs and low-profit margins (Twin Disc's trailing 12-month net profit margin currently comes in at 3.58%), it is a necessity to turn over capital quickly in order to grow the business.

This paradigm, unfortunately, becomes ultra-difficult when the company cannot get products fast enough (Such as electric components) from its suppliers on the front end and when Twin Disc's customers do not order fast enough on the back end. Essentially, this paradigm means more working capital commitments from TWIN which really is the opposite of what Twin Disc needs to be doing in order to grow the business.

The good news however for the bulls is that shares are up over 12% since that December piece with the company's recent second-quarter earnings numbers in February being the catalyst for the jump higher. Although Twin Disc met earnings estimates in the quarter ($0.08), shares have managed to punch above their 200-day moving average as we see below.

The long-term chart however paints a different picture due to the sustained pattern of lower lows which really has been the norm since 2011. In saying this, that multi-year downcycle trendline of over $20 a share (Which is major overhead resistance in itself) is still a realistic target for Twin over the near term. To do this, shares must first take out their 2022 highs which should then result in a trending move.

Q2 Earnings

Although Twin Disc's lack of profitability in recent times may disinterest some investors, this does not mean this stock is without opportunity. In fact, Twin Disc's second-quarter earnings numbers gave us a glimpse of how the company's fortunes could improve in the right trading environment.

On a constant currency basis, sales jumped by over 14% with the North American oil and gas sector, in particular, reporting better demand. Furthermore, as mentioned earlier, TWIN posted a bottom-line Q2 beat of $0.08 per share or $1.1 million. Given these results (And taking TWIN's very low sales multiple into account), here is how Twin's financials would change for the better if trading conditions were to continue to cooperate

Decreasing inventory levels (which management is forecasting for the remainder of the year) will free up working capital and prompt more cash-flow generation. Then through a sustained re-opening of the Chinese market post-covid and better internal inventory planning, more cash should come on stream which will facilitate elevated investment if needs be.

Value Continuing To Be Added

Moreover, management has been able to keep a lid on rising costs by increasing its prices both in Q1 & Q2 of this year. Then, investors should look at the value Twin's customers are bringing to their markets over time which should be a positive tailwind concerning demand. The CEO touched on this recently citing Grizzly's new 3,000 horsepower electric frac pump offering and Snow & Company's Research Vessel which are value-adding updated products incorporating Twin's technology.

Therefore as alluded to earlier, it is all about turning over that demand and inventory as quickly as possible to ensure this "value" can essentially get to market on a large scale. Doing this will increase Twin's return on invested capital which will facilitate strong production and inventory efficiencies. Twin's strong balance sheet has enabled the company to withstand very difficult recent trading conditions but we need higher ROIC numbers for a sustained rally to ensue. Obviously, trading conditions have to cooperate but we see the market giving Twin Disc some leeway here if momentum can be sustained.

Conclusion

Twin Disc announced a much better set of quarterly earnings for its second quarter. Sales and earnings beat estimates for the quarter as a result of much-improved demand in the North American oil and gas market as well as the global marine and industrial space. The longer shares can remain above their 200-day moving average, the more elevated the possibility of a trending move to the upside. We look forward to continued coverage.

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