By and large, sell-side analysts can be a vengeful lot. Companies that make them look bad by over-promising and under-delivering often get stuffed into the penalty box and forced to do penance for a time. That doesn't seem to be the case with Ingersoll-Rand (IR), though, as this company enjoys a surprising amount of sell-side support - at least surprising relative to the company's performance in recent years. (See earnings call transcript.)
A Pretty Mediocre End To The Year
Ingersoll-Rand announced that reported revenue fell more than 5% in the fourth quarter, though organic/"core" revenue was actually up slightly (on the order of 1-2%). Even still, the company did come up a little short.
The Climate business showed the biggest dichotomy, as a divestiture led to a greater than 7% decline in reported revenue. Underlying revenue was actually pretty strong (up about 5%). The Industrial business was fairly strong (up more than 7%), while the security business was soft (down 3% organically), and the residential business was very weak (down 13%).
Profitability was actually fairly good. Gross margin improved more than a full point, while operating income rose almost 7%. That said, Ingersoll-Rand beat analyst estimates only because of a lower than expected tax rate and share count, so it was a low-quality beat.
Will The Restructuring Ever Deliver?
Ever since Ingersoll-Rand management started talking about restructuring back in 2008, investors have been waiting to see the fruits of those labors. For the most part, that's been a wait in vain as the company still trails most of its peers in terms of margins.
That said, maybe management deserves a break. About two-thirds of this business is exposed to construction (residential and non-residential) and it is hard to dramatically improve your internal operations when your end-markets are in free-fall. To that end, while many other industrial companies like Dover (DOV), Emerson (EMR), and Danaher (DHR) are back to, or above, their prior peak North American performance, Ingersoll-Rand is still well below.
Once Bitten, Twice Shy?
Comparing Ingersoll-Rand's guidance to its peers and rivals, I'm led to wonder if management is being conservative. Relatively speaking, the company seems more cautious on the construction and truck markets than the likes of Eaton (ETN), Illinois Tool Works (ITW), Siemens (SI), Emerson or Dover.
That's despite the fact that Ingersoll-Rand's results this quarter generally compare pretty favorably to those from Emerson, United Technologies (UTX), and Illinois Tool Works. Moreover, the Architecture Billings Index and the NAHB Index both seem to be picking up off the bottom and that has historically been a good sign for construction activity.
Despite this unimpressive run for Ingersoll-Rand, they seem to have held on to most of their commercial business share relative to Johnson Controls (JCI) and United Technologies. In residential, the company seems to be past the R-22-related missteps that caused problems. As such, IR should be in good shape to post a solid sales recovery if and when that construction recovery materializes.
The Bottom Line
Ingersoll-Rand is a frustrating stock to figure out today. On one hand, IR has very clearly suffered from a lousy end market that management could do little to change. What's more, execution in the relatively healthier industrial business has been improving and may be a sign of what is to come when those construction markets recover.
Investors have reason to be cautious here and there is a long record of under-performance. Those analysts giving Ingersoll-Rand the benefit of the doubt are projecting solid mid-single-digit revenue growth and free cash flow conversion rates in the high single-digits. Those numbers easily support a mid-$50's target price, but also represent a level of performance that the company has only achieved twice in the last ten years.
The good news is that a more modest projection would still seem to offer relatively little down side. If Ingersoll-Rand can deliver 7% free cash flow conversion by 2014 (versus a trailing 10-year average of 5.5% and a 6.5% or so average before the construction sector collapsed), fair value falls into the mid-$40's.
That still represents above-average performance, though, and assumes some recovery in construction. Accordingly, risk-tolerant investors may want to give this one a serious look, but investors less willing to bet on a turn in construction may be better off in names like Siemens, Dover, or Emerson.