Colfax: Recovery Could Be Coming Sooner Than Expected

Includes: CFX, GDI, GGG
by: Ben Axler

Colfax Corp (NYSE:CFX) reports earnings tomorrow and all signs point to a quarter where investors can start to be optimistic about the company's future. We thought it worthwhile to review the business and some of the reasons why Spruce Point Capital is bullish on the share price.

Company Overview:

Colfax is a global supplier of a range of fluid handling products, including pumps, fluid handling systems and controls and specialty valves. The Company is a manufacturer of rotary positive displacement pumps, which include screw pumps, gear pumps and progressive cavity pumps. It offers customized fluid handling solutions to meet individual customer needs. Colfax also sells replacement parts and performs repair services for its manufactured products. Its products are marketed under the Allweiler, Fairmount, Houttuin, Imo, LSC, Portland Valve, Tushaco, Warren and Zenith brand names. The Company has production facilities in Europe, North America and Asia.

Segments and Applications:

Commercial Marine: Fuel oil transfer; oil transport; water and wastewater handling; cargo handling

Oil and Gas: Crude oil gathering; pipeline services; unloading and loading; rotating equipment lubrication; lube oil purification

Power Generation: Fuel unloading, transfer, burner and injection; rotating equipment lubrication

Global Navy: Fuel oil transfer; oil transport; water and wastewater handling; firefighting; fluid control

General Industrial: Machinery lubrication; hydraulic elevators; chemical processing; pulp and paper processing; food and beverage processing; distribution

Company History:

Founded in 1995 (investors including the Rale brothers / Danaher) with the intention to acquire, manage and create a world-class industrial manufacturing company. Businesses and brands acquired date back to the 1860s. CFX has acquired businesses with leading market positions and brands that exhibit strong cash flow generation potential. On May 13, 2008, CFX completed its IPO of 21.5m shares at $18/sh. Of the 21.5m shares sold in the offering, 11.8m shares were sold by the Company and 9.7m shares were sold by certain selling stockholders. The Company received net proceeds of approximately $193m, and used these proceeds to: (i) repay approximately $105.4m of indebtedness outstanding under its credit facility, (ii) pay dividends to existing preferred stockholders of record immediately prior to the consummation of the IPO in the amount of $38.5m, (iii) pay $11.8m to the selling stockholders in the IPO as reimbursement for the underwriting discount incurred on the shares sold by them, and (iv) pay special bonuses of approximately $27.8m to certain executives under previously adopted executive compensation plans. The remainder of the net proceeds was applied to working capital.

Business Breakdown by the numbers:

o Global: ~76% of sales in 2009 were delivered to customers outside of the U.S. Products sold through more than 300 direct sales and marketing associates and approximately 250 authorized distributors in more than 100 countries.
o Customer Diversity: No single customer represented more than 4% of sales in 2009. Sales to U.S. government defense agencies and government contractors are ~4% of sales. Sample customers (Alfa Laval, Cummins (NYSE:CMI), General Dynamics (NYSE:GD), Hyundai Heavy Industries (OTC:HYHZF), Siemens (SI), Solar Turbines, Thyssenkrupp (OTCPK:TYEKF)).
o Recurring Revenues: 24% of sales were derived from aftermarket sales and services.
o Sales by product: Pumps/After-mkt services (84%), Systems/Installation (13%), Valves (2%), Other (0.5%).
o Sales by end mkt: General Industrial (34%), Marine (26%), Oil/Gas (17%), Power Generation (14%), Navy (9%).
o Backlog: $290.9m as of 12/31/09 w/70% expected to be shipped during 2010.


Highly fragmented and competes in selected niches of the fluid handling industry; no single company competes directly with CFX across all of their markets.

Growth Strategy and Drivers:

Colfax growth is guided by Colfax Business System (CBS). CBS is a disciplined strategic planning and execution methodology designed to achieve excellence and world-class financial performance in all business aspects by focusing on the Voice of the Customer and continuously improving quality, delivery and cost. Modeled on the Danaher Business System, CBS focuses on conducting root-cause analysis, developing process improvements and implementing sustainable systems.

  • Acquisitions: Consolidate the fragmented markets CFX operates in
  • Grow Offerings of Systems and Solutions
  • Target Faster Growing Regions by Leveraging a Global Manufacturing, Sales and Distribution Network
  • Develop New Products, Applications and Technologies

Why are CFX's shares attractive?

1) Exposure to attractive end markets and global reach

As noted above, CFX has exposure to diverse infrastructure end markets with stable and growing characteristics. Furthermore, most of the Company's sales are outside the US, where growth rates are higher. In particular, CFX sells into Europe, which is improving much faster than the market expected. To illustrate, look at Weir's recent earnings surprise which sent shares up over 15% this week.

2) Undervalued relative to peers

Colfax is a good business, with a strong pedigree modeled after Danaher, that went public at the wrong time. Financial performance had been the strongest in history, but suddenly decelerated due to the financial crisis. As a result, shares were quickly discarded by shareholders and may be viewed as a busted IPO. CFX's valuation is at a meaningful discount to other pump/valve manufacturers on an EBITDA and P/E basis. Shares of Colfax have lagged the market since coming public in 2008. Despite having most sales tied to general industrial markets, CFX shares have also lagged indices such as the DJIA. CFX also appears to get a discount for being a small cap. The company also has some legacy asbestos litigation from two acquired businesses, but has seen an increasing number of these claims being settled in recent years. CFX carries insurance and estimates net expected cash outlay on a non-discounted basis for asbestos-related bodily injury claims over the next 15 years was $54.3m as of 12/31/09

Assuming CFX received a valuation in-line with peers, we believe the shares would be worth between $16-$20, therefore, we have an $18 price target.

3) Strong potential for upgrades

CFX is currently rated as neutral/hold by most analysts across The Street and viewed as a later-stage cyclical play. As signs of an economic recovery become increasingly clear, we believe investors may soon focus on names like CFX. CFX also announced a newly appointed CEO, Clay H. Kiefaber, in January, succeeding John A. Young. Kiefaber spent nearly 20 years in increasingly senior executive positions at Masco Corporation (NYSE:MAS) and has served on Colfax's Board of Directors since the Company's IPO in 2008. In February, the company offered annual guidance based on current backlog and order rates, of organic sales to decline in the range of 5%-9% and Adj EPS of $0.67-$0.77 for 2010. We believe annual guidance was likely conservative and offers upside potential due to improving end markets.

To illustrate, last week a few of CFX's peers announced strong earnings beats, upgrades, and strong share price appreciation. Graco (NYSE:GGG) significantly beat estimates and cited strong increasing int'l demand in emerging/developed countries; shares jumped 10% on the news. Gardner Denver (NYSE:GDI) also announced a strong earnings beat, raised guidance, and saw its share price rise 7%. As previously discussed, Weir Group (WEIR) also announced strong earnings.

Other catalysts for an upgrade could be accretive acquisitions by using the Company's under-leveraged balance sheet.

Disclosure: Long CFX