2023-10-12 08:20:02 ET
Summary
- Brady Corporation continues to deploy capital to drive sales growth and productivity, while resolving supply chain issues and experiencing increased demand for productivity solutions.
- The company faces challenges from economic uncertainty and a demand slowdown in the US, particularly in the healthcare industry, but expects its operating margin to benefit from normalized freight rates in FY2024.
- BRC aims to grow above the GDP growth rate and improve profitability through organic investments, acquisitions, dividends, and share buybacks, with a medium-term outlook suggesting a higher return.
BRC Offers A Value Proposition
I have been discussing Brady Corporation (BRC) in the past, and you can read my latest article here . The company will keep deploying capital to drive sales growth and productivity. It has continuously increased dividends for several years and repurchased shares as part of its effort to enhance shareholder returns. Recently, it seems to have resolved the supply chain issues. Also, demand for its productivity solutions has increased. The other key growth driver would be the higher demand for productivity solutions.
But it will continue to face the impact of economic uncertainty and demand slowdown in the US. The effect of the slowdown was prominent in the healthcare industry following the pandemic, supply chain and logistics challenges, and inflationary pressures. I expect its operating margin to benefit from the normalized freight rates in FY2024. The stock appears to be reasonably valued versus its peers. With a brighter medium-term outlook, I suggest investors "hold" the stock with an expectation of a higher return.
Industry Outlook
One of BRC's key strategies is to grow above the GDP growth rate. US GDP's average quarter-over-quarter growth rate was 1.4% over the past two years until Q1 2023. However, GDP quarterly growth rate declined to 1% in the past quarter. The US Manufacturing PMI increased to 48.9 in September 2023 from 47.9 in August but remains below 50, indicating a contraction.
Despite subdued demand, the companies have improved their supplier performance, reducing the need to hold stock of finished goods. In this environment, BRC will look to improve profitability and increase long-term shareholder value through organic investments, acquisitions, dividends, and share buybacks.
Finance Strategy
In FY2023, BRC repurchased ~3% of its diluted share count as part of a previously announced $100 million share buyback program. It has a policy of allocating cash to fund organic sales. The initiatives include new product development, enhancing sales generation, and increasing capital expenditures.
Even during periods of economic uncertainty, it is committed to deploying capital to drive sales growth and productivity. It also aims to increase dividends. During Q4 2023, the company increased its annual dividend for 38 consecutive years.
FY2024 Outlook
In FY2024, BRC's management expects its earnings per share to increase by 9% (at the guidance mid-point) compared to FY2023. It expects organic sales to grow by "mid-single digit." The weakening of the US dollar can add 200 basis point growth to its FY024 revenues.
Geographic Market Growth And Challenges
One of the critical challenges the company faced over the past couple of years relates to the healthcare industry's struggle. It has slowed down following the pandemic, supply chain and logistics challenges, and inflationary pressures. In Q4 2023, its operations in China and South-East Asia declined due to a demand pushback in the consumer electronics industry. However, India continued to grow (by 15%-20%) annually, expecting further growth in 2024.
In the US and Europe, the company's sales grew due to supply chain shortening and higher demand for its productivity solutions. The company's Australian business growth in Q4 culminated in profit growth. The segment profit from Europe and Australia increased by 9.1% in Q4.
Q4 Performance Analysis
The company's organic sales grew 5.6% in the Americas and Asia region in Q4 2023, while the segment profit increased by 17.2%. Apart from the organic sales growth, the effect of freight rates returning to normal in 2023 benefited the segment operating margin.
In FY2024, the company's margin will benefit from the normalized freight rates. In Europe and Australia, organic sales growth (9.5% up) outperformed the Americas and Asia. However, the segment operating profit saw a muted growth of 9.1%.
Dividend And Dividend Yield
Brady's annual dividend increased by 2% to $0.94 per share, with a 1.72% forward dividend yield. MSA Safety's ( MSA ) forward dividend yield is 1.18% for a yearly dividend of $1.88.
Cash Flows And Shareholders' Returns
In FY2023, BRC's cash flow from operations increased by 77% compared to a year ago, led primarily by working capital improvement. Free cash flow (or FCF) increased even more sharply, by 152%, in this period. In FY2024, the company expects capex of $75 million, including a purchase of a previously leased facility and the build-out of a new facility.
The company's debt-to-equity (0.05x) is much lower than its competitors (MSA, RRD, and DOV). The management continues to prioritize shareholder returns and share buybacks.
Analyst Rating And Relative Valuation
Seeking Alpha says two sell-side analysts rated BRC a "buy" in the past 90 days, while none rated it a "hold." One of the analysts rated it a "sell." The consensus target price is $61, suggesting a 10% upside at the current price.
BRC's forward EV/EBITDA multiple contraction compared to its current EV/EBITDA is less steep than its peers. This typically results in a lower EV/EBITDA multiple because its EBITDA is expected to rise less sharply than its peers. The company's EV/EBITDA multiple (10.1x) is lower than its peers' (MSA, CMPR, and DOV) average (15.1x). So, the stock appears to be reasonably valued versus its peers.
Given the recessionary fear in the US, I do not see the stock improving sharply in the short term. However, if it trades at the past average in the medium term, it can climb 12% from the current level.
Why Do I Keep My Call Unchanged?
I did several iterations of my analysis about BRC in the past. The common themes that cut across the analysis are investing in R&D, marketing, and automation. It also aimed to increase pricing and was on a share repurchase program. Cash flows, however, were a problem.
In my previous article, the company shifted to cost reduction initiatives to improve margins. Demand for Brady's IDS productivity solutions products will rise. However, demand slowed down as inventory fell throughout its distribution network. Cash flows, on the other hand, improved significantly. I wrote :
the company's primary focus is to contain the cost hike seen in the previous quarters. The company's operating profit in the European and Australian businesses increased handsomely in Q3. Its operating profit in the European and Australian businesses has expanded.
In FY2023, the company faced a few obstacles, particularly concerning the healthcare industry following the pandemic, supply chain and logistics challenges, and inflationary pressures. Demand for its products declined in China and South-East Asia declined. However, in the Americas and Asia region, its revenues and profit grew due to the improvement in the supply chain. Its cash flows continued to improve. These factors validate my continued "hold" recommendation on the stock.
What's The Take On BRC?
BRC, which, in my view, systematically depends on the general economic growth, will likely face headwinds from low US GDP growth and industry activity constraints in the near term. The struggle is apparent in the healthcare industry in particular. Except for a few pockets of growth, the problem was pervasive in most regions.
However, by the end of 2023, the company's sales started recovering in the US and Europe due to supply chain shortening. Its organic sales growth was impressive in Europe and Australia in Q4. Its leverage (debt-to-equity) is much lower than its competitors. This, coupled with an improving cash flow, increased dividend, and share repurchase, put its balance sheet at a premium. So, the stock outperformed the SPDR S&P 500 ETF ( SPY ) in the past year. Despite the challenges, the drivers are steady enough to rebuff the current obstacles, making the stock apt for a "hold."
For further details see:
Brady Corporation Focuses On Shareholder Returns