Summary
- MSA Safety had a better than expected fourth quarter, with good sales execution on healthy underlying demand and good operating leverage.
- Management was a little careful with 2023 guidance, but municipal fire/rescue, oil/gas, and mining should all be relatively stronger markets and MSA has shown it can outgrow its markets.
- MSA has an enviable track record, parlaying average-looking revenue growth into margin/FCF leverage, improved returns, and good core book value growth.
- MSA Safety seldom looks all that cheap, and today is no exception, but the market has long been willing to pay up for above-market growth with incremental margin leverage.
I love below-the-radar companies with top-tier performance, and I think MSA Safety ( MSA ) still qualifies. Barely covered by the Street, this company is hardly a household name, despite #1 or #2 share in businesses that cover over 90% of its revenue, a track record of margin and ROIC leverage, and double-digit long-term growth in tangible book value per share (an underrated statistic, in my view). Moreover, in the near term, I like the company’s leverage to strong municipal spending on fire/rescue services and later-cycle end-markets like oil/gas and mining.
Although “below the radar” can sometimes mean undervalued, that’s not really the case here. MSA has seldom traded cheap by conventional standards, though the shares have appreciated by about 12% a year over the last decade, not too far off well-loved high-multiple multi-industrials like AMETEK ( AME ) and Roper ( ROP ).
Another Beat In The Books
With balanced growth across much of the business, MSA logged another better-than-expected quarter, with upside on both revenue and margins relative to Street expectations.
Revenue rose 12% on a core constant currency basis, with the Breathing Apparatus business up 14%, Fixed Gas and Flame Detection up 14%, Fire Helmets and Apparel up 6%, Industrial Head Protection up 12%, Portable Gas Detection up 22%, and Fall Protection flat.
MSA is a little more challenging to benchmark, as many of its chief rivals are part of large conglomerates (like 3M ( MMM ) and Honeywell ( HON )). Even so, looking at the 14% growth from IDEX ’s ( IEX ) Fire & Safety / Diversified Products (or FSDP) segment (which is about 60% fire/rescue equipment), Oshkosh ’s ( OSK ) commentary on healthy municipal fire/rescue demand, 2% growth in Honeywell’s Sensing and Safety Technologies business, and 4% adjusted growth in 3M’s personal safety business, I’m comfortable saying MSA performed well this quarter.
Despite ongoing inflationary pressures, margin leverage was solid. Gross margin improved 110bp to 44.5%, while adjusted EBITDA rose 18% (margin up 210bp to 24.4%, and adjusted operating income rose 20% (margin up 210bp to 21.6%).
Free cash flow for the full year was a little lackluster, down 26% year over year and only 7.5% of revenue, but like so many companies MSA is carrying higher working capital in an attempt to offset supply chain challenges and work off its backlog.
Management Seems Cautious, But End-Markets Should Be Supportive
Management guided to mid-single-digit revenue growth for 2023, with a stronger performance likely in the first half and admitted uncertainty and poor visibility into the second half of the year. Guidance also included “healthy” incremental margins and improved cash flow conversion, as that excess net working capital should start reversing.
I think that cautious guidance is prudent at this point, but I do think that MSA could have opportunities to outperform given its end-market exposures.
Fire/rescue spending is healthy now, and I expect this to continue at least through 2023 given more robust municipal budgets and overaged equipment. Although Breathing Apparatus sales growth of 15% year-over-year (the 2022 growth rate) isn’t sustainable, a five-year growth rate of about 4% suggests some ongoing opportunity to benefit from equipment refresh spending. Helmets and protective apparel have been stronger for longer, though, so I could see more of a slowdown here.
Outside of fire/rescue, which is around 40% of the business, I’m bullish on the company’s exposure to end-markets like oil/gas and mining for gas/flame detection and worker safety. Healthy commodity prices and new brownfield and greenfield projects are driving both oil/gas and mining, and I expect these markets to remain healthy through at least 2024. I also see ongoing opportunities for MSA to leverage its IoT capabilities as operators upgrade to intelligent passive monitoring systems to enhance worker safety and lower operating costs.
I’m less bullish on the company’s exposure to general industrial and construction end-markets. I continue to expect activity to slow here, and I think the low-to-mid single-digit growth here seen by Honeywell and 3M is probably an accurate reflection of slowing demand as companies step back from hiring and as construction projects slow. Given my expectations of ongoing reshoring, though, as well as a significant acceleration in infrastructure projects in 2024 and beyond, this should be a relatively healthy business on balance and MSA has a track record of outgrowing underlying industrial production by 200-300bp.
I should also note that the company goes into 2023 with a backlog that is 25% larger than the prior year. Orders were up in January, but I wouldn’t be surprised to see orders weaken as the year goes on. Even so, that backlog should help protect at least the first half of the year (likely why management was noticeably more confident about the prospects for the first half of the year).
The Outlook
Given my general bullishness on fire/rescue spending, as well as the health of later-cycle markets like oil/gas and mining, I feel pretty good about MSA’s prospects in 2023. I do see some risk of a slowdown in 2024/2025, though, as the municipal refresh cycle plays out and later-cycle end-markets slow. Even if that should materialize, though, I think underlying growth in areas like IoT-enabled gas/flame detection is sturdy, and I likewise think that MSA can still gain share through innovation in areas like breathing devices and through more international expansion.
Longer term, I think mid-single-digit revenue growth is a reasonable expectation for MSA. On the margin side, I’m expecting around two points of EBITDA margin improvement over the next three years, and I’m expecting FCF margins to move from the low double-digits toward the mid-teens over the next decade. If that can be done, revenue growth of around 5% will drive double-digit FCF growth.
None of that makes for an easy valuation argument, though. Discounted cash flow doesn’t really get me to an exciting place, even giving MSA a privileged (lower) discount rate to account for strong market share, above-market growth, margins, and so on. Likewise, using my margin/return methodology to drive an EBITDA multiple and giving MSA a two-point quality premium gets me to 15.5x my ’23 EBITDA estimate, or basically in line with today’s price.
The Bottom Line
Perhaps I’m being too stingy with a two-point EBITDA multiple premium or not bullish enough on my margin assumptions. Whatever the case, I can’t really make a compelling valuation argument. That’s often the case with other high-quality industrials, though, and the Street has shown a consistent willingness to pay up for them anyway. That could well be the case here, but I’m more comfortable with the risk of missing out rather than overpaying.
For further details see:
MSA Safety Delivering Well On Less Cyclical Opportunities