2024-01-19 18:06:38 ET
Summary
- Columbus McKinnon's financial metrics are improving, but it has a high level of debt and slowing revenue growth.
- The company's current ratio indicates it has no liquidity issues, but its return on assets and return on equity are low.
- The company's valuation suggests it is trading at fair value, but further improvement in metrics is needed before committing capital.
Investment Thesis
Columbus McKinnon ( CMCO ) is due to report third-quarter earnings at the end of the month, so I wanted to look at the company's financials to see if it would be a good time to start a position. The metrics seem to be improving from the recent lows of the pandemic, and the efficiency is improving also, however, the company has a lot of debt on its books and the revenue growth seems to be slowing down, which may signal that the company is running out of steam organically and inorganically through acquisitions. I am assigning a hold rating for now, until I see further proof that the company can maintain higher margins and is going to pay down the debt.
Briefly on the Company
CMCO is a leader in intelligent motion control solutions that specializes in the design and production of equipment designed for lifting, securing, and pulling. It is a very trusted player in the game as it has been around since 1875.
The company offers products such as hoists, wire rope slings, winches, and rigging equipment. One of their more prominent products is the CM Lodestar electric chain hoist, which is known for its durability and reliability.
Financials
As of Q2 '24, the company had around $100m in cash and equivalents, against $514m in long-term debt. That is half of the company's current market cap. Many investors avoid such companies that seem to overindulge on leverage, however, there are a few metrics I like to look at to see if this amount of debt will be a problem for the company.
The company’s debt-to-assets ratio has been ranging from 0.2 to 0.3, which is more than acceptable. I consider anything under 0.6 to be not overleveraged compared to the company’s assets. The next metric I like to look at is the company's debt levels compared to shareholder equity. For this metric, anything under 1.5 I consider not overleveraged. Over the last 5 years, the company reached as high as 0.7, which is well under my threshold, so the debt is not an issue in terms of equity also. Lastly, to make sure the company can pay its annual debt obligations, I like to look at the company’s interest coverage ratio. Here, analysts look for at least a 2x, which means that the company can pay its annual interest expense 2 times over with the EBIT generated. In my opinion, a 2x is a little too close for comfort, as it barely allows for bad years of performance when EBIT may not be as robust, and the interest expense will eat into the company’s flexibility. I prefer that companies achieve at least a 5x, and unfortunately for CMCO, it stood at around 3 as of Q2 '24, which isn’t bad, however, I will have to add a bit more margin of safety to the valuation, as I like to be more on the conservative side. Nonetheless, the company is not at risk of insolvency.
The company’s current ratio has been outstanding over the years, and the only gripe I have with it is that it’s almost too high. It’s been as high as 2.8 and as low as 1.8. I like to see the current ratio anywhere between 1.5 to 2.0, which I consider efficient, as it means the company has plenty of liquidity to pay off its short-term obligations and still have enough left over for further growth of the company, while not hoarding too much cash on books. As of Q2 ’24, the company’s current ratio stood at around 1.94, so it’s safe to say the company has no liquidity issues.
The company's margins over the last 3 years have been recovering to the levels they've been in FY19. Gross margins have already passed those levels, which means the company is having an easier time producing the product at cheaper input costs. The company has seen a fantastic recovery since the pandemic lows, which shows the resiliency of the company and the management's commendable job.
Continuing on efficiency and profitability, it is no surprise that when margins started to improve, ROA and ROE followed suit, although not as quickly as margins. These are still well off of their highs of the last 5 years and have been lingering around these levels for a while now, which is not what I like to see, especially when they are so low. I’d like to see at least 5% for ROA and 10% for ROE in the future.
In terms of return on total capital compared to its peers (as picked by Seeking Alpha), the company is somewhere in the middle, which means it has some sort of competitive advantage in the sector, but we can also see that it has come down a lot over the last 5 years, which is not ideal.
In terms of revenue growth, it hasn't been very impressive, although if we look at the last 3 years of growth, something seems to have shifted. A combination of stronger organic growth and inorganic growth through acquisitions seems to be propelling its revenues to new levels. Analysts are estimating FY24 revenue growth to be around 8%. The question is if it can be sustained going forward.
Overall, the company looks to be recovering well from the lows of the pandemic. Margins are slowly improving, and the acquisitions seem to be contributing to the company's top line. The company's debt is a little high, which is not too bad if the company performs better but if we see a downturn, that interest expense will eat through the company's operating profit.
Valuation
I like to approach my models with a conservative mindset, to give myself more room for error and a better margin of safety. So, for revenue growth, I decided to incorporate analysts' estimates for FY24, which is around 8% growth. After that, I decided to grow the company's top line at around 4% CAGR for the next decade. I also like to include an optimistic case and a more conservative case, to give myself a range of possible outcomes. Below are those assumptions and their respective CAGRs.
For margins and EPS, I am approaching these estimates more conservatively also than what the analysts are estimating the company will do. I do this to give myself even more margin of safety, as I would like to not overpay for a company and have a better risk/reward outcome. Below are those estimates.
For the DCF analysis, I went with the company's WACC of 8% as my discount rate and 2.5% as my terminal rate. I feel I didn't need to use a higher discount rate than that because the growth and margins are already on the lower end. Furthermore, I am adding another 20% margin of safety to the intrinsic value calculation just to beat the estimates down and stress test the company. With that said, CMCO's intrinsic value is around $35.40 a share, which means the company seems to be trading at its fair value.
Closing Comments and Takeaways
I would like to see the company's mentioned metrics improve further before committing any capital as most of them are quite under my thresholds (ROA, ROE, and ROTC specifically). It also seems that the revenue growth is starting to slow down, and I am worried that it will not go above 5% in the long term. That would be fine with me as long as the company manages to improve margins further, as that is how I think the company can unlock the most value, by becoming much more efficient and profitable.
Starting a position right now is not a bad idea, however, I don't think we are out of the uncertainties of the macro economy, and there will be further volatility going forward in my opinion. If you are to open a position right now, you would have to be comfortable with more fluctuations going forward. The company seems to be in a good position to perform in the long term, so these fluctuations shouldn't matter, however, I am going to be waiting around for a little longer. I'd like to see the company tackling the debt and what the company thinks about the upcoming year in terms of demand and efficiencies. The company is due to report Q3 earnings at the end of January, so I will be looking forward to hearing their plan. For now, I am assigning a hold rating to the company.
For further details see:
Columbus McKinnon: Metrics Are Improving But Not Where I'd Like Them To Be Yet