2023-06-06 11:41:00 ET
Summary
- Barnes Group Inc. has been struggling in recent years.
- The company has made a massive bet on growing its better performing aerospace segment.
- I like the move, but leverage is high, and the past performance is not inspiring, leaving me cautious about Barnes Group here.
It has been a long time since I covered shares of Barnes Group Inc. ( B ) , in fact it was the summer of 2016 when I concluded that shares started to look appealing on dips amidst its continued long term transformation. That conclusion made sense as shares rose quite a bit through 2018, but ever since investors have seen dreadful results on the back of poor operational performance.
A History Of Transition
Barnes has a long history of transforming the business, a successful strategy of keeping the business up to date and allowing it to pay out dividends for more than 80 years in a row back in 2016.
At the time, Barnes was a $1.2 billion business with an industrial segment responsible for about two thirds of sales, generated from engineered components and molding solutions in the automotive and general industrial applications. This was accompanied by an aerospace segment which mostly catered to original end manufacturers.
While these in general are pretty solid businesses to operate in, sales have been rather flat in the years leading up to 2016, as operating margins improved by four points to 14% of sales in the ten-year period leading up to that point in time, in part because of some portfolio reshuffling and focus on higher margin activities.
When I looked at the company, Barnes paid $136 million to acquire German-based Adval Tech's mold business in a rather bolt-on deal. With 55 million shares trading at $36, the company commanded a $2.0 billion equity valuation, although net debt rose to $650 million including pension liabilities and the impact of the latest deal, for about a 2.5 times leverage ratio.
With earnings power seen around $2.50 per share, and realistic earnings coming in about 10% lower, the resulting 15-16 times earnings multiple looked fair, given the leverage employed and the not-so-inspiring track record of the business (in recent years) at the time.
Back To The Present
Forwarding seven years in time, we see that Barnes has utterly disappointed its investors. Shares trade at $41, resulting in just very modest capital gains for investors, with shares up 10-15% over a seven-year time span, even as the dividend yield has risen to just 1.6%.
Note that shares have seen a high of $70 in 2018 amidst the America-first policies employed by president Donald Trump at the time, but ever since shares have come down as shares did not participate in the post-pandemic run in the equity markets.
Forwarding to February of this year, Barnes posted its 2022 results with sales reported flat at $1.26 billion, in line with the 2016 numbers. Adjusted earnings rose four points to $1.98 per share as the lack of complete progress can be explained by tougher margins in the industrial segment, and, of course, pressure on the aviation segment during the pandemic period.
Needless to say, flattish sales over a seven-year period indicate toward real positioning issues, or execution issues, certainly as sales are down if we adjust for higher inflation here. Moreover, net debt came in close to $500 million, as there was no surprise in this area as well, making me very cautious.
This was the case even as the company provided an apparently solid guidance for 2023, with sales seen up between 6 and 8%, with adjusted earnings up to $2.10-$2.30 per share.
In April, Barnes posted solid first quarter numbers with sales up more than 7% to $335 million, with adjusted earnings up six cents to $0.47 per share, although that restructuring charges made that GAAP earnings came in at roughly half that number. On the back of this solid result, the company hiked the lower end of the earnings guidance by five cents to $2.15 per share.
With 51 million shares now trading at $41, the company commands a $2.1 billion equity valuation, with the dollar valuation amount being in line with the valuation in 2016 amidst some buybacks. The business trades around 18 times adjusted earnings, but it is clear that some improvements can be done, perhaps requiring the involvement of some outsiders. With a $2.6 billion enterprise valuation, the company trades around 2 times sales here.
A Big Deal
Early in June, Barnes announced a deal to acquire MB Aerospace. Barnes is acquiring the aero-engine component manufacturing and repair services company in a $740 million deal. The UK-based business has operations in the U.S., Poland and Taiwan as well outside the operations at home.
The unit will nearly double the aerospace business of Barnes as it adds $330 million in profitable revenues with EBITDA reported at $65 million, for a near 12 times multiple, as cost synergies of nearly $20 million will push the transaction multiple below 10 times. Net debt will essentially jump to about $800 million, pushing up leverage to an estimated midpoint of 3.8 times. That seems a bit high in my calculations, but let´s see how it turns out.
In all fairness, the acquisition multiple look reasonable as aerospace has been the stronger segment within Barnes. In fact, it might even open the way for a complete focus on aerospace over time, in part because leverage is a bit high. Pegging interest costs at 5%, incremental interest costs will eat a significant portion of the acquired EBITDA, certainly as I allow for some D&A as well. This makes that accretion is likely limited, while the near term leverage will skyrocket, but the overall long term positioning will improve.
And Now?
The truth is that I am too disappointed by Barnes Group Inc. in its historical performance to get involved here. That being said, the latest deal looks interesting from a deal valuation perspective and the positioning towards its better-run aerospace segment, although that leverage is a bit too high for my taste in the near term.
This deal has the potential to improve the positioning and performance over time, although the lagging industrial segment would have to be transformed, or (partially) divested.
Amidst all this, Barnes Group Inc. remains a show-me-first story, although an interesting one to cover with some greater frequency going forward.
For further details see:
Barnes Group: Something To Prove After Greater Focus On Aerospace