Crane: Selloff Likely Overdone

| About: Crane Co. (CR)

Summary

Crane equity is down 50% from recent highs.

While there are reasons for a pullback, the selloff is likely overdone.

Crane continues to generate solid cash flows, and its free cash flow yield is favorable.

Crane (NYSE:CR), like many long-lived publicly-traded industrials, has a storied past. Founded in the mid-1800s, the company started out making simple metal items for use in the railroad industry. For more than a hundred years, the company has continued to evolve and adapt from those humble beginnings, always managing to survive and even thrive in what has been rapidly changing market environments.

Crane was severely impacted by the 2008 recession, falling nearly 75% from its 2008 high in just a few short months from June to November. As a result, an immense amount of shareholder value was destroyed as investors fled to safe-haven assets. Luckily, the world did not end in 2008, and since then the shares have rallied, with shares up at one point nearly 700% from those dark times. The volatility in Crane stock, like many stocks that sunk at that time, was a prime example of market inefficiency and overreaction.

We're starting to see those signs again. While not obvious to many, the pain in many industrials has been widespread in 2015, and Crane stock is down nearly 50% again. Is this another short-lived bump in the road for a company that has endured dozens of economic downturns and negative market events in the past?

Business Lines

Crane operates its businesses under four distinct categories:

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*Note: 2015 numbers include my estimates for Crane in Q4 2015.

Fluid Handling (43% of 2014 sales) sells valves, couplings, piping, fittings, etc. These products are primarily sold to demanding industrial customers, such as those in the oil and gas, power generation and petrochemical industries. Operating margin totaled 14.4% before corporate adjustments in this segment in 2014.

Payment & Merchandising (24% of 2014 sales) designs and manufactures of various unattended payment-receiving equipment and associated technologies. You might find Crane-built equipment on your local Pepsi vending machine or bank ATM. This segment was transformed by the acquisition of MEI in 2013, which was a leading competitor of Crane prior to the deal.

Aerospace & Electronics (24% of 2014 sales) sells a wide swath of products, from landing gear, sensors, fluid management systems such as fuel and coolant pumps, and wireless communications equipment to commercial and military aerospace customers, primarily to OEMs like Boeing (NYSE:BA) and Airbus (OTCPK:EADSY).

Engineered Materials (9% of 2014 sales) sells fiberglass-reinforced plastic panels used in RVs and tractor trailers.

Crane's business model has never been about gaining extreme size just for the sake of it. It has remained a smaller company by choice, instead choosing to focus on niche markets where it can gain significant market share and earn outsized returns. These markets are generally small enough to keep larger competitors like Tyco (NYSE:TYC) and Cameron International (NYSE:CAM) from intruding because they aren't large enough addressable markets for them to want to compete in. As we can see below, operating margins are quite good in these businesses:

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*Note: 2015 numbers include my estimates for Crane in Q4 2015.

So why the sell-off in Crane equity?

The downturn in Crane has primarily been driven by falling revenue and operating margin erosion in its Fluid Handling business. As the largest and oldest operating segment, its health is integral for the company going forward, and unfortunately results have been weak. Reasons for this run the gambit from a shift toward an unfavorable sales mix, increasing competition, weakening demand across all geographies, and unfavorable foreign currency translation impacts. All this has resulted in operating income for this core segment from $182M in 2014 to an expected $128M in 2015 before corporate overhead adjustments. For a company that only generates a little over $400M in operating income pre-overhead, such downtrends have outsized effects on the business.

Unfortunately, these trends don't appear to be reversing anytime soon. Demand appears to have continued dropping in the segment, with backlog falling from $350M at the end of 3Q 2014 to $279M at the end of 3Q 2015. Given the lack of revenue growth elsewhere, payment and merchandising growth has almost been purely acquisition driven.

Cash Flows

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*Note: 2015 numbers include my estimates for Crane in Q4 2015.

Crane's cash flow generation has been steady and healthy, and the recent pullback has pushed the company's free cash flow yield to 6.3% based on likely 2015 results. While not stellar, this is still above average, and combined with other valuation measures, such as the company's EV/EBITDA valuation of 7x, there is likely some value at these price levels.

Conclusion

Crane equity has been battered recently, but shares have been punished a bit too much. While I don't think the stock is deserving of a return to $75/share, fair value is likely around $54-60/share, provided the business stabilizes and does not deteriorate further. While not a screaming buy, I see no reason for Crane shareholders to head for the exits now, and I would recommend continuing to hold.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.