Columbus McKinnon: Wide-Moat Hidden Champion Trading At Less Than 8x EV/EBITDA

Aug.19.14 | About: Columbus McKinnon (CMCO)

Summary

Recent share price decline of approximately 20% for Columbus McKinnon provides buying opportunities.

Wide-moat hidden champion status validated by the largest installed base of hoists in North America and market-leading position in products which account for three-quarters of its sales.

Recent management changes should drive international expansion plans.

Positive on recent capital allocation initiatives with initiation of dividend payment.

A potential catalyst will be better-than-expected progress in M&A activities.

Elevator Pitch

Columbus McKinnon (NASDAQ:CMCO) has seen its share price decline by approximately 20% in the past three months, down from its five-year peak of $30.58 in May 2014. I believe that the recent share price pullback represents an opportunity for investors to buy into a wide-moat hidden champion like Columbus McKinnon at attractive valuations at under eight times trailing twelve-month EV/EBITDA. Columbus McKinnon's wide-moat status is derived from low customer price sensitivity, its scale and a lean, cost-conscious culture. Looking ahead, it should continue to grow the revenue contribution from international emerging markets, and any significant uptick in M&A activity could act as a potential catalyst for the stock.

Company Description

Columbus McKinnon is a manufacturer and marketer of material handling products, systems and services, such as hoists, cranes, actuators and rigging tools. These material handling products are used by its clients to efficiently and ergonomically move, lift, position and secure materials.

Wide-Moat Hidden Champion

There are different ways to assess the quality of a company, which has led certain companies to be categorized as either wide-moat companies or hidden champions based on certain characteristics. A wide-moat company is one with sustainable competitive advantages and high barriers to entry, evidenced by consistent profitability and market share stability; while a hidden champion is a market leader either globally or in any specific continent in terms of market share, with sales under $4 billion, operating out of the public limelight. In my opinion, Columbus McKinnon ticks the boxes of most criteria for these two categories of quality businesses.

For the past decade, Columbus McKinnon has been free cash flow-positive in nine out of the past 10 years, and its gross margins have stayed consistently high in the 24%-31% range over the same period. With respect to market dominance, Columbus McKinnon holds the largest domestic market share in products, representing 74% of its fiscal 2014 U.S. sales. In its largest product category of hoists, trolleys and components, accounting for 63% of its 2014 domestic revenues, Columbus McKinnon's products nearly make up close to half of the industry's output, at 46% market share. In addition, Columbus McKinnon's sales are under a billion dollars, and material handling products and supply chain news are simply not as exciting as social media or biotechnology stocks.

There are three key reasons why I believe Columbus McKinnon will remain a wide-moat hidden champion for the foreseeable future.

Firstly, Columbus McKinnon's product costs remain small relative to the benefits that it brings to its customers. Close to 80% of its revenues are generated from products that are sold at under $5,000 per unit. In comparison with the relatively low unit price, material handling products play an important role in helping companies improve efficiency, enhance productivity and maximize profitability. This is evidenced by Columbus McKinnon's gross margin expansion in the past few years since the Global Financial Crisis. It has increased its gross margin from 24.1% in fiscal 2011 to 31.0% in fiscal 2014, and achieved the 15th consecutive quarter of gross margin expansion Q1 2015. This has been contributed by a mix of price increases, operating leverage effects (spreading higher sales volume over a fixed cost base) and operational excellence. Columbus McKinnon's ability to raise prices is reflective of the relative price insensitivity of its customers, due to the cost-benefit trade-off of its products.

Secondly, Columbus McKinnon's size is a key competitive advantage in many ways. One factor is cross-sales and follow-on sales. Columbus McKinnon's largest installed base of hoists in North America allows it to cross-sell complementary and new products to its existing customers and benefit from after-market sales for replacement units and components and repair parts. Another factor relates to the overall sourcing strategy for distributors and end-customers. On one hand, they want to do bulk purchasing with a fewer number of material handling product suppliers to improve efficiencies; on the other hand, they are wary of supplier concentration risks and out-of-stock scenarios. Columbus McKinnon addresses both of these issues. It is a one-stop shop for material handling equipment, with such a broad product offering that no single SKU represents more than 1% of its sales. In addition, Columbus McKinnon also boasts an in-stock guarantee for over 275 hoists and rigging products, which are available for shipping to customers in less than three days. As a result, Columbus McKinnon's distributors-customers do not have to stock up on excess inventories and worry about unreliable and untimely product deliveries to end-customers. Moreover, Columbus McKinnon's authorized network of 16 chain repair stations and in excess of 200 certified hoist service and repair stations across the country gives its customers the confidence that they will receive strong after-market sales and support.

Thirdly, Columbus McKinnon has in place a lean, cost-conscious culture. The various ways that it has reduced costs include consolidating manufacturing facilities, applying "Lean" techniques and expansion of cost-efficient manufacturing platforms abroad. The numbers speak for themselves. While Columbus McKinnon grew its top line from $480 million in 2002 to $583 million in 2014, it has got leaner. Over the same period, Columbus McKinnon's number of major manufacturing facilities declined from 20 to 13, while in terms of manufacturing square feet, the metric fell by almost half from 2.7 million square feet to 1.5 million square feet. In fiscal 2014 alone, Columbus McKinnon recorded productivity gains amounting to $3.2 million as a result of 88 active "Lean" projects and localization of manufacturing in China, among other initiatives.

Fuelling International Ambitions

Columbus McKinnon has undergone a gradual transformation over the past 18 years. While it used to be a domestic-focused company in 1996 (when it listed), with 84% of its sales coming from the U.S., it has a far more balanced geographical revenue profile now, with non-U.S. markets accounting for 43% of its FY2014 fiscal sales.

Recent management changes suggest that Columbus McKinnon is getting serious about expanding its international operations. At the start of the year, in January, Mr. Jeff Armfield joined Columbus McKinnon as executive director, Global Product Strategy and Development, where he will be responsible for new product development from the design phase through execution globally. Jeff was previously with AxleTech International as global director - Engineering and Product Management, where he held responsibility for AxleTech's global product development. In the exact words of CEO Timothy T. Tevens, "product development is a critical function to ensure that we successfully maintain our strong market position in developed markets, and to drive further penetration in emerging markets." In April 2014, Columbus McKinnon announced that it had created a new Global Services Group to focus on nurturing key customer relationships in greater depth. Mr. Gene Buer, who joined Columbus McKinnon in 2005, and formerly held the position of vice president Hoist & Rigging Products - North America and Global Vertical Markets, will head the new group as vice president, Global Services and Vertical Markets. The renewed focus on both product development and customer relationships should put Columbus McKinnon in a good position to expand its businesses in international markets.

Management has guided that Columbus McKinnon's long-term objectives are to grow its top line from $583 million in FY2014 to eventually cross the $1 billion mark. With respect to the geographical mix, Columbus McKinnon targets one-third of the $1 billion sales to be derived from developing markets, which will allow it to capitalize on the more attractive growth prospects in these regions. This target will likely be achieved with a mix of organic (expanding sales presence) and inorganic (M&A) strategies. As of end-FY2014 (year ended March), Columbus McKinnon has nine and eight sales office in China and Latin America respectively. Going forward, it has plans in place to set up new sales offices in Turkey, Morocco and UAE, and drive greater sales volume from existing distribution channels and sales offices in Mexico, Brazil, Poland and Russia. On the other hand, Columbus McKinnon also estimates that between $200 million and $300 million of the uplift in sales to meet this $1 billion target will come from acquisitions. With its debt-total market capitalization currently at approximately 30%, Columbus McKinnon estimates that it still has debt capacity of about $100 million, given that it sees room to increase leverage to the debt-total market capitalization ratio of 50% at the maximum.

Capital Allocation

On March 24, 2014, Columbus McKinnon announced that its Board of Directors has approved the initiation of a regular quarterly dividend of $0.04 per common share. On an annualized basis, the annual dividend rate of $0.16 will represent a dividend yield of 0.65%, based on the closing price of Columbus McKinnon on August 15, 2014 of $24.53.

This is a move in the right direction by Columbus McKinnon to reward shareholders, given its solid balance sheet and strong free cash flow generation. Its gross debt-to-equity ratio is at a manageable 50%, and it is close to a net cash financial position, with net debt of $38 million representing less than 8% of its market capitalization. In addition, Columbus McKinnon has been free cash flow-positive in nine out of the past 10 years.

In the Columbus McKinnon's 2014 Annual Report, the chairman and CEO wrote that "we intend to pay a regular dividend through all stages of the business cycle and reward our shareholders by strategically increasing it as we grow." More importantly, this helps to ensure that Columbus McKinnon will not splurge cash on acquisitions or growth opportunities with sub-par returns, as it will be "forced" to balance its competing capital allocation needs in a logical and value-accretive manner.

Potential Catalysts

The analyst consensus revenue estimates for Columbus McKinnon are $605 million and $641 million in fiscal 2014 and 2015 respectively, representing year-on-year sales growth rates of 3.8% and 6.0%. This is line with Columbus McKinnon's historical three-year and 10-year sales CAGR of 3.6% and 2.8% respectively. At the Q1 2015 results conference call, Timothy Tevens, the CEO, mentioned that its current M&A pipeline mainly comprises companies in the $30-$50 million revenue range. I think any upside from an acquisition of a company boasting revenues over $100 million, or a string of M&As in quick succession could significantly shorten the time required for Columbus McKinnon to hit the $1 billion revenue mark and drive its share price.

Valuation

Columbus McKinnon's current valuations look undemanding from both a historical and a peer comparison basis. At 7.5 times trailing twelve-month EV/EBITDA, Columbus McKinnon is currently valued at the lower end of its three-year EV/EBITDA trading range of between 5 and 25 times. Columbus McKinnon also trades at a discount to its closest listed comparable, Terex Corporation (NYSE:TEX). Columbus McKinnon trades at a trailing twelve-month EV/EBITDA of 7.5, compared with 8.6 times EV/EBITDA for Terex. Terex' subsidiary, Demag Cranes competes with Columbus McKinnon in hoists and cranes. Terex is a more diversified company than Columbus McKinnon, operating in five business segments: Aerial Work Platforms, Construction, Cranes, Material Handling & Port Solutions and Materials Processing.

Variant View

Columbus McKinnon's biggest risk lies with the economy. Notwithstanding its economic moat, Columbus McKinnon's material handling equipment business is a cyclical one, with its sales strongly correlated with industrial capacity utilization. If the economy performs worse than expected in any of the regions that Columbus McKinnon operates in, demand for material handling products will fall, and Columbus McKinnon's financial performance will be adversely affected.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.