2023-11-10 12:22:33 ET
Summary
- Ingersoll Rand's stock is up over 25% since my previous recommendation earlier this year and I see a further upside.
- IR offers a good buying opportunity with promising revenue growth prospects and a focus on sustainable-end markets and reshoring trends.
- The company's revenue in Q3 2023 increased by 14.7% YoY, driven by organic growth and acquisitions.
- Ingersoll Rand's margins are expected to see gains from operating leverage and a focus on high-margin aftermarket revenue, contributing to overall margin growth.
Investment Thesis
Ingersoll Rand Inc. ( IR ) is up more than 25% since I recommended buying earlier this year. Despite significant outperformance compared to the broader markets, I believe the stock still offers a good buying opportunity. The company’s revenue growth should benefit from solid backlog levels. Further, investments in new and innovative product offerings and technologies in high-growth sustainable-end markets and growth opportunities from the ongoing reshoring trend should help the revenue growth in the coming quarters. Apart from organic growth, the company’s bolt-on M&As strategy which focuses on acquiring higher growth and higher margin businesses should also aid the revenue growth in the near term as well as long term.
On the margin front, the company’s margins should see gains from operating leverage from revenue growth. In addition, the company's focus on leveraging the IIoT to grow high-margin aftermarket revenue should also contribute to the margin growth. In terms of valuation, the stock is currently trading at a discount as compared to its historical valuation. Given the company’s promising growth prospects and lower-than-historical valuation, I have a buy rating on IR stock.
Revenue Analysis and Outlook
Ingersoll Rand’s revenues have benefitted from solid end-market demand as well as bolt-on acquisitions in recent years. In the third quarter of 2023, IR reported a 14.7% Y/Y increase in revenue to $1.739 billion driven by a 6.4% Y/Y increase in organic revenues, a 6.9% contribution from acquisitions, and a 1.4% favorable impact of FX translation. In the Industrial Technologies & Services ('ITS') segment, revenue grew 19.1% Y/Y on a 9.5% Y/Y rise in organic revenues while in the Precision & Science Technologies ('PST') segment, revenue declined 1.8% Y/Y with a 5.3% Y/Y decline on an organic basis. The revenue decline in the PST segment was due to tough comparisons and normalization in demand from oxygen concentrators and biopharma industries after the strong last couple of years. However, moving forward, the comparisons are easing which should help it in the coming quarters.
Looking forward, I remain optimistic about the company’s near and long-term growth prospects. The company ended last quarter with a backlog up 6% Y/Y which bodes well for sales growth in Q4 2023 and FY 24. While total orders were down 1% Y/Y and organic orders were down 8.2% Y/Y, it was primarily due to tough comparison in the ITS segment which saw a high teens increase in orders in Q3 2022. Management guided for a sequential as well as Y/Y increase in orders in Q4 as the comparisons ease.
The company continues to execute well focusing on high-growth sustainable end markets and launching energy-efficient products to accelerate market share gains in these markets. The company recently launched a new IIOT-ready oil-free compressor in North America which, according to management , is 14% more efficient than the previous model and 5% more efficient than the competition. As noted in my previous article , almost 30% of the company’s revenue is from water-efficient products, and 100% is from energy-efficient products. With more and more clients targeting being more sustainable, the company has a good opportunity to gain market share.
The company is also poised to benefit from the recent reshoring trend catalyzed by the Federal Stimulus in the form of the CHIPS and Science Act and the Inflation Reduction Act. With the companies moving their manufacturing facilities to the U.S., Ingersoll Rand’s sales should benefit in the medium to long run. On its last earnings call, answering a question around the mega-project pipeline that is building up as a result of this reshoring trend, the company’s chairman, CEO & President Vicente Reynal said,
... if you remember a few quarters or even last year, we spoke a lot about a lot of these kind of large projects that were being in conversations. And now we're seeing definitely the release of some of those funds. And so yes, so that's what's giving us a bit of a higher level of confidence in terms of how the long cycle funnel continues to build in a company that gives us a good level of visibility, I'll say, not only Q4 but also as we go into 2024.”
As these projects continue to progress, the coming sales should benefit in the coming years.
In addition to good organic growth prospects, the company’s strong balance sheet with net leverage of ~0.9x positions it well for inorganic growth. The company has done a good job in terms of bolt-on M&As so far this year and has increased its inorganic revenue target for FY 2023 by $360 million. I expect this inorganic growth to continue in the coming years as well.
Overall, I believe the company can post mid-single-digit organic growth in the coming years helped by a solid backlog, good execution, and reshoring mega trend. This coupled with bolt-on M&As can push the total growth to high single digits.
Margin Analysis and Outlook
In Q3 2023, the company saw a 170 bps Y/Y expansion in adjusted EBITDA margin to 26.5%. Segment Wise, the ITS segment’s adjusted EBITDA margin improved by 260 bps Y/Y due to pricing strength and strong operational execution driven by Ingersoll Rand Execution Excellence (IRX). In the PST segment, the adjusted EBITDA margin increased 120 bps Y/Y driven by price/cost improvements and synergy realized from recently completed M&A. Margin expansion in both ITS and PST segments led to a Y/Y increase in total adjusted EBITDA margin for the company.
Looking forward, the company’s margin should continue to benefit from operating leverage as a result of higher sales. Management has indicated incremental margins in the mid-30s for the company. Further, the company is targeting to increase its aftermarket services revenues as a percentage of total revenues from the mid-30s to mid-40s by leveraging the Industrial Internet of Things (IIOT) and offering customer service contracts, part subscriptions, and system optimization services. The aftermarket business carries a higher margin and its growth should improve the margin mix for the company. So, I am optimistic about the company’s margin prospects as well.
Valuation and Conclusion
IR is currently trading at a forward P/E of 23.30x FY23 consensus EPS estimate of $2.88 and a 21.28x FY24 consensus EPS estimate of $3.15 which is a discount compared to its 5-year average forward P/E of 33.81. I believe there is a potential for the stock to re-rate to the mid-20s P/E, in line with high-quality industrial compounders.
The company possesses good near-term and long-term growth prospects supported by various factors including solid backlog, growth in order bookings, and good execution through new and innovative product launches that align with current megatrends like sustainability, accretive M&As, and rising opportunities from reshoring trends. The margin outlook is also positive, with benefits from operating leverage and an improved mix of more profitable aftermarket business. Considering these solid growth prospects and a cheap valuation, I have a buy rating on the stock.
For further details see:
Ingersoll Rand: Good Revenue Growth Prospects