2023-08-22 04:51:26 ET
Summary
- Barnes Group's stock is overvalued to fairly valued due to concerns around its M&A activity.
- The company's industrial segment has shown poor growth, leading to a focus on the more dynamic aerospace division.
- Barnes Group's recent acquisition of MB Aerospace is expensive and carries significant execution risk, raising concerns about future M&A activity.
Barnes Group ( B ) is a successful company focused on the Industrial and Aerospace sectors, but we believe that the stock is overvalued based on concerns about its valuation and m&a capabilities. The current multiples fail to properly evaluate the organic growth rate. We believe that in order to keep the same generous valuation, Barnes would need to aggressively pursue a new m&a for which it does not have the cash.
The business and the poor growth story
Barnes reported earnings very recently, on July 28. During the call and in the presentation management focused on some key aspects like (1) “optimization” of the industrial segment, and (2) growth at the Aerospace segment. Indeed, performance at the former has not been particularly comforting, with management noting that:
For industrial, organic orders were flat as compared to a year ago, though book-to-bill was approximately 1.1 times.
We think this is the main reason behind the decision of moving much of the long-term efforts to the more dynamic aerospace division. And there the company expects favorable conditions, as we understand from this extract:
Our OEM business will benefit from ongoing production rate increases by both Boeing and Airbus. In the aftermarket, we continue to deliver strong sales growth given improved passenger traffic and the resurgence of wide-body activity.
Basically, the company believes in a strong comeback driven by healthy and sustained improvements in demand for airlines. This should come both from commercial and defense-related products. The idea is to bring revenues (and the rich cash generation) back to pre-COVID levels of around $370 million of revenues for the OEB (Original Equipment Manufacturer) segment.
Revenue (Latest Presentation)
But what about current results? The remaining focus as we said was on the “optimization” of the industrial business.
Revenues and Margins - Industrials (Latest Presentation)
This is how the segment developed in the last years. As one can immediately see operating margins are decreasing and close to depressed levels. Management is pushing for a reorganization plan that aims to drive these numbers up again, and the recent earnings likely missed the analysts’ expectations on this point. This slower-than-expected schedule, along with weak demand is increasing our concerns on the two points of our thesis: valuation and m&a activity.
An expensive stock and a cash-poor company do not make an attractive mix
If a company struggles to grow above single digits organically, it will likely push those numbers with some aggressive m&a activity. This is the case for many companies, and Barnes is no exception. In the pre-covid years, they spent large sums on big acquisitions, spending on average $130 million per year on average between 2013 and 2020. Then COVID came and they suddenly stopped. Now, along with the optimization plan and a renewed focus on Aerospace, the company went back with a strategic acquisition: MB Aerospace for around $740 million of total consideration. With roughly $75 million of cash on hand, the acquisition is essentially an LBO, financed mostly with likely expensive debt. The takeover is happening at 11.4x times the 2023 EBITDA of MB and will increase net leverage from around 2.0x to 3.7x.
We clearly do not like the deal for various reasons. First of all, it is a very expensive acquisition in terms of balance sheet impact and it will be financed at high rates. The company is pursuing one of the biggest acquisitions of its history while interest rates are at the highest levels in more than 20 years, leaving very little room for error.
Then, we believe that the expected synergies will be very difficult to materialize, and there is significant execution risk embedded in that process.
Geographical Presence (Latest Presentation)
MB has operations in virtually every corner of the world, with different jurisdictions and regulations that will make the collection of synergies at the very least a long process. We are concerned that Barnes won’t be able to cash in on all these efficiency gains, thus making the acquisition way more expensive and unable to generate the target ROI.
Another concern is if the company starts engaging in more m&a. This is taken from the slide deck posted in August. The company mentioned that they are willing to evaluate more targets despite the large MB acquisition. This could mean more expensive debt, more leverage, and more execution risk.
Aerospace Overview (Latest Presentation)
Valuation: comparative analysis while weighting the concerns
In terms of valuation compared to peers Barnes Group is not that bad. We think that the company executed well so far with the exception of the overmentioned delays on the “optimization” schedule. However, the market is probably weighing the same concerns that we share on the upcoming m&a wave, and assigning a discount in terms of multiples.
Valuation multiples (Seeking Alpha)
As one can see the EV/EBITDA and EV/Sales are somewhat aligned with peers, with a slight discount on the former. We think that this is close to Barnes's fair value, with some more considerations to help readers understand this take:
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The MB acquisition presents both risks and opportunities. We would like to take a wait-and-see approach and judge on valuation multiples as the synergies and the integration take place over time.
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The low cash balance means that any further m&a (and also the MB acquisition itself) needs to be funded with much-expensive debt. This creates an additional layer of risk and transfers some wealth away from shareholders to debtholders.
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The growth profile and the optimization strategy seem to be falling somewhere below the Street’s expectations. Again, we would like to see more progress before increasing the target multiples.
We conclude that a fair value range would be between 9.5 and 10 times EBITDA, which means a fair value per share between $35 and $37.5.
Conclusions
Barns Group is undergoing some significant changes, with an optimization plan being executed at their industrials division, while the aerospace segment eyes expansion through m&a. We think there are many risks, from execution to financing, currently looming over the business. For this reason, we would like to take a wait-and-see approach to the valuation and wait for more clarity as the strategy is executed.
For further details see:
Barnes Group: Valuation And M&A Concerns After Recent Earnings