2023-10-27 17:56:45 ET
Summary
- Barnes Group Inc. has experienced a significant decline in its share price due to worse-than-expected operating performance and high leverage.
- The company recently acquired MB Aerospace, adding to its debt load and raising concerns about future earnings accretion.
- Barnes Group's third quarter results showed a rapid deterioration, leading to a dramatic cut in adjusted earnings guidance and further concerns about leverage.
Early in the summer, I believed that Barnes Group ( B ) had something to prove after it created some greater focus on the aerospace segment. After the business was struggling in recent years, the company made a big bet to grow its aerospace segment. With an uninspiring past performance and quite some leverage incurred, I was turning quite cautious on Barnes.
Since June, shares of the company have been cut in half, as Barnes is suffering from a worse than previously thought operating performance, but more so the leverage overhang from a substantial deal. The combined effect quite frankly makes me cautious to buy this substantial dip here.
Continued Transition
Barnes has a long history of transforming its business, as continued alterations to the business have allowed it to remain in existence for such a long period of time. The business itself was founded in 1857 already, and the company is in its 90th consecutive year of paying out dividends.
Forwarding to February 2023, the company posted its 2022 results with revenues reported at $1.26 billion, unchanged compared to the year before. Even if I add back a $68 million goodwill impairment charge, operating profits fell from $150 million in 2021 to $125 million in 2022. Adjusted for this charge, and some other smaller items, adjusted earnings rose some four cents to $1.98 per share.
Two thirds of the business was generated from industrial markets, mostly derived from molding solutions, motion control solutions, and to a minor extent from automation. The remaining one third of sales is generated from the aerospace market, mostly from OEM's, but it includes a substantial aftermarket service business as well.
The company ended 2022 with a net debt load of nearly $500 million, translating into a leverage ratio of 2.3 times. With shares trading at $40, which resulted in a 20 times earnings multiple for a business which did not grow (and operated with over 2 times EBITDA in net debt), I was quite cautious.
This was even the case as the company guided for 2023 sales to increase by 6-8%, with adjusted earnings seen up to $2.10-$2.30 per share, as the lower end of the full year guidance was hiked by five cents following the first quarter earnings report. Trading at $41 in June, the 51 million shares outstanding granted the business a $2.1 billion equity valuation, or $2.6 billion enterprise valuation.
A Big Deal
In June, Barnes announced a $740 million deal to acquire MB Aerospace, an aero-engine component manufacturing and repair services. The UK-based business has activities across the globe, adding $330 million in revenues and about $65 million in EBITDA, with costs synergies seen at $20 million.
Pro forma net debt ratios would jump to 3.8 times according to the company itself, which made me cautious in this higher interest rate environment, while Barnes itself was not performing on fire for quite a while (which is an understatement). Furthermore, a lot of leverage would be added, while little earnings accretion was seen as well.
A Huge Disappointment
Given the past disappointment and risks related to the deal, I found it very easy to avoid the shares in June at $40, as shares have been falling to the lower thirties already in the fall amidst concerns of slower economic growth and the impact on the business. What followed was a bombshell earnings report which sent shares down to the $20 mark here.
Towards the end of July, Barnes posted a 6% increase in second quarter sales to $339 million, with adjusted earnings per share up just 4% to $0.58 per share, as the company maintained the full year adjusted outlook with earnings seen between $2.15 and $2.30 per share.
The company closed on the MB Aerospace on the final day of August. In part due to a more expensive $650 million term loan, the transaction was not accretive in the near term, in fact the contrary. For the remainder of 2023 up until now, the company believed that MB Aerospace would contribute some $110 million in sales, but be dilutive to the extent of $0.25 per share. This is a substantial amount of dilution, certainly as it applies to just a third of the year, making me frankly quite cautious.
Towards the end of October, Barnes reported its third quarter results. Revenues rose 15% to $361 million, with growth up 4% excluding the contribution of MB Aerospace. The problem was adjusted earnings, which fell thirty cents to $0.19 per share, with GAAP losses coming in at $0.43 per share, mostly due to deal-related costs.
The company cut the full year adjusted earnings guidance to $1.57-$1.67 per share, a dramatic cut of course, in part due to a mere 0.6 book-to-bill ratio in the aerospace segment this quarter, and 0.8 times ratio for the entire firm.
What Now?
The big elephant in the room for Barnes is a big net debt load of $1.22 billion, which is of course quite high, but certainly is high in relation to the shortfall in the business.
The 51 million shares outstanding have now fallen to the $20 mark, with the equity valuation of a billion now being less than the net debt load. In fact, shares have lost over a billion dollars in value, to a great extent likely the result of the (leverage incurred with the) acquisition of MB Aerospace, which came at an upfront cost of $740 million.
While Barnes Group Inc. has not yet posted an EBITDA number for the third quarter (with the 10-Q filing still due), and the results show quite a rapid deterioration, the concerns here are clearly related to leverage. With earnings power just over $1.50 per share, the earnings multiple has fallen from 20 times to 13 times here, with earnings power likely trending lower as the added earnings power is not sufficient to offset incremental interest expenses.
The business is now posting about $1.5-$1.6 billion in sales, and with adjusted operating profits seen in the low double digits, let's say around 12%, adjusted EBIT is seen around $180-$200 million. After adding back reasonable depreciation expenses, EBITDA of around a quarter of a billion dollars translates into leverage ratios of around 5 times, but this is an uncertain number, of course.
It is the leverage concerns surrounding Barnes Group Inc. which stood at the basis of my caution in June and have materialized quicker and in a larger fashion than I could reasonably suspect. Given the rapid pace of the deterioration in the business, I find it too early to get involved with Barnes, even as the selloff has been huge.
For further details see:
Barnes Group Q3 Earnings: Heavy Turbulence