2023-08-17 13:06:22 ET
Summary
- Tennant Company stock has seen significant appreciation, but further upside is likely due to strong sales, profit, and cash flows.
- The company has demonstrated growth in revenue through both higher prices and higher volume, signaling strength in the market.
- Management has increased guidance for the current fiscal year, forecasting higher revenue, earnings per share, and EBITDA.
One of the great things about companies that continue to grow, especially if they grow at a nice clip, is that they can continue to be fundamentally attractive from a valuation perspective even as their share prices increase. One really great example of this can be seen by looking at Tennant Company ( TNC ), a business that is engaged in the production and sale of mechanized cleaning equipment that's used largely for industrial and commercial purposes.
Shares are up significantly since I started writing about the company back in September of last year. But even with the appreciation that the stock has seen, I would argue that further upside is likely on the table. Because of this, I have decided to keep the company rated a 'buy' for now, reflective of my view that the stock should outperform the broader market moving forward.
Cleaning up nicely
The most recent article that I published about Tennant Company came out in early March of this year. In that article, I found myself impressed by these strong sales, profit, and cash flows that the company continued to generate. Management also stressed that the 2023 fiscal year should be another period of growth for the company which, when combined with how cheap the stock was, convinced me to keep it rated a 'buy'. Since then, shares have jumped 18.6% compared to the 12.6% seen by the S&P 500. And since I first rated the company a "buy" back in September of last year, the stock has seen upside of 41.1% stacked up against the 16.7% achieved by the S&P 500 (SP500).
You would think that, after seeing so much upside, I would wax neutral or even bearish about the firm. But my opinion of it changes as the facts do. Consider how the firm has performed during the first half of the 2023 fiscal year . During that window of time, revenue came in at $627.5 million. That represents an increase of 16.6% over the $538.3 million management reported one year earlier. This jump in revenue was driven by strong organic growth of 17.9%. This was offset to some extent by a 1.3% hit associated with foreign currency fluctuations.
Many companies have demonstrated growth in revenue in recent years as a result of higher prices, sometimes at the expense of volume. That, to me, signals weakness ahead in most instances. Fortunately, that is not the case when it comes to Tennant Company. In the first six months of this year, the company benefited to the tune of 10% from price increases. However, higher volume also pushed revenue up by 7.9%.
Management even said that all the regions in which it operates showed strong demand for its equipment, with the Americas proving to be a particularly attractive space. In fact, revenue in the Americas jumped 24.3% during the first half of 2023. That compares to the 3.9% increase from the EMEA (Europe, Middle East, and Africa) regions, and the 1.8% growth seen in the Asia Pacific region.
With this increase in sales also came a surge in profits. Net income more than doubled from $26.9 million to $55.6 million. The increase in revenue certainly helped. However, the company also benefited from an increase in its gross profit margin from 38.1% to 42.2%. This improvement can really be chalked up to the aforementioned higher pricing that more than offset inflationary pressures. Meanwhile, selling and administrative expenses dropped from 28.9% of sales to 26.9%. That decline was driven by cost containment initiatives implemented by management, as well as greater operating leverage that came from the increase in revenue.
Other profitability metrics for the company also improved during this time. Operating cash flow went from negative $23.6 million to positive $70.2 million. If we adjust for changes in working capital, it nearly doubled from $47.5 million to $80.7 million. And finally, EBITDA for the business expanded from $58.2 million to $105.5 million.
For those worried that the picture might be weakening as time goes on, I need only point to the chart above. In it, you can see that revenue, profits, and cash flows, were all significantly stronger in the second quarter alone relative to the same time last year. Although volume growth was weaker than what it was in the first half of the year as a whole, it was still 5.7% above what it was in the second quarter of 2022. Price increases helped the company to the tune of 9.3% as well.
On top of the recent financial performance, the company has also been bullish enough to increase guidance for the current fiscal year in its entirety. As you can see in the image above, revenue is now forecasted to come in at between $1.20 billion and $1.25 billion. At the midpoint, that is 7.9% above what management previously forecasted sales would be. Earnings per share and EBITDA are also expected to come in far stronger than prior guidance suggested. At the midpoint, earnings per share should translate to profits of $86.5 million. Meanwhile, EBITDA should come in at around $182.5 million. No guidance was given when it came to operating cash flow. But if it grows at the same rate that EBITDA is forecasted to, then, on an adjusted basis, it should be roughly $145.8 million.
Using these estimates, I was able to create the chart above. In it, you can see how the company is priced on a forward basis for 2023. You can also see how it is priced using results from 2022. Relative to the data that we get for 2022, shares are definitely more expensive than when I last wrote about the company. But on a forward basis, the pricing is not much different. Yes, the price to earnings multiple has increased from 17.5 to 18.3. However, the price to adjusted operating cash flow multiple has dropped from 11.2 to 10.8, while the EV to EBITDA multiple has fallen from 10.4 to 9.7.
Relative to similar firms, the stock is also more or less fairly valued. As you can see in the table below, two of the five companies are cheaper than Tennant Company on a price to earnings basis. And when it comes to the other two valuation approaches, three of the five ended up being cheaper than our target.
Company | Price/Earnings | Price/Operating Cash Flow | EV/EBITDA |
Tennant Company | 18.3 | 10.8 | 9.7 |
Mueller Industries ( MLI ) | 6.7 | 5.6 | 3.9 |
SPX Technologies ( SPXC ) | 67.3 | 132.5 | 28.9 |
Mayville Engineering Co ( MEC ) | 19.3 | 8.3 | 6.6 |
The Timken Co ( TKR ) | 13.3 | 9.4 | 8.6 |
Parker Hannifin ( PH ) | 25.9 | 18.1 | 16.1 |
Takeaway
From what I can see, Tennant Company is doing really well. I continue to be impressed with strong fundamental performance and with how shares are responding to that performance. I do believe that the easy money has probably been made by this point. But given how Tennant Company shares are priced and assuming that management comes through on guidance, I see no reason to believe that the stock shouldn't appreciate further from here. Because of this, I have decided to, once again, reiterate my 'buy' rating.
For further details see:
Tennant Company: There's Still Upside To Capture