Not only do I like industrial companies in general, but small industrial companies are near and dear to my heart. Played right, they can be surprisingly lucrative stock picks with much less of the risk that often goes with small technology or healthcare names.
The question for this article, then, is whether Altra Holdings (AIMC) merits a spot in the portfolio of growth-inclined investors.
An Annoying Reset To End The Year
The Altra Holdings case doesn't start off especially strong, as though revenue rose 11% organically in the fourth quarter, the company missed earnings estimates by a significant margin.
Margins were actually the problem. Altra came up short on the gross margin line due in large part to inventory de-stocking in Europe, production disruptions tied to weather, and some higher healthcare costs. All of that said, operating income did still rise 20% and the company is ahead of schedule in integrating its Bauer acquisition.
Under The Radar, But Not Unknown
Altra won't be familiar to many investors (my own autocorrection thought I meant to write on Altria), but the company is considerably more well-known to its customers. Altra provides niche power transmission products and holds the #1 or #2 position in most of its addressed markets with brands like Boston Gear and Warner Electric. Once Altra gets business, it tends to hang on to it - due in no small part to the fact that about two-thirds of products are customized in some way.
About 40% of Altra's sales fall into the bucket of "general industrial", with metals/mining and energy standing out as other 10%+ addressed markets. From conveyor belts to elevators to construction machinery to oil wells, Altra's clutches, brakes, couplings and bearings find their way into products sold by Deere (DE), Toro (TTC), General Electric (GE), and National Oilwell-Varco (NOV).
Dodging The Elephants
Altra's focus on niche markets and customized products gives it an edge competing with far larger rivals like Emerson (EMR), Regal-Beloit (RBC), and ABB's (ABB) Baldor. Large companies don't always respond well to customers with finicky requirements and that creates an exploitable opportunity for Altra; as does the fact that Altra can profitably target markets too small to be efficiently addressed by Emerson or ABB.
That said, discrete automation and industrial motion has been getting more attention lately as big companies look to bulk up and round out their product offerings (as in the case of ABB and Baldor).
To that end, it would not be surprising if Siemens (SI) or Rockwell (ROK) were to kick the tires on this company, particularly as the company moves into new markets like wind and hydro power, mining, and food processing - all areas where Siemens and Rockwell have vested interests. Likewise, Altra's strong position in energy and industrial markets would seem to be a potential fit for Dover (DOV) as well.
Can They Deliver Operational Leverage?
Just because Altra may look superficially like a good fit for Siemens or Dover is no guarantee that either would bid, nor that management is interested in selling. This is a company that has built itself through numerous acquisitions and builders are not always inclined to become sellers.
The question, then, is whether Altra can deliver better performance. If you consider the fact that Altra often has #1 or #2 market positions and seldom loses established business, you would think that the margins and returns on capital would be solid. That is unfortunately not the case, as margins and returns have both been fairly poor.
Here is where I bring another small industrial company into the story. Sauer-Danfoss (SHS) likewise had an unimpressive legacy of weak margins and low returns on capital before the recession essentially forced the company to do better or go away. Since then, the company has gotten very serious about reducing operating costs, growing its emerging markets exposure, and delivering generally better overall results.
Altra would seem to be a company that could benefit from a similar self-improvement plan. The integration of Bauer will certainly help (including bringing Bauer up to Altra's level of performance), but the key to Altra working as a stock will lie in boosting free cash flow conversion from its historical level of about 4% to something more on the order of Emerson or ABB's high single-digits/low teens.
The Bottom Line
I would argue that Sauer-Danfoss is a good example of what can go right with a small industrial restructuring story. Just as Sauer-Danfoss has carved out a recently lucrative business with a niche market focus that allows it to compete effectively with Eaton (ETN) and Parker-Hannifin (PH), I believe Altra can do the same despite competing with the likes of Emerson and ABB.
The quality of Altra as a stock pick really does revolve around just how fast and how far the company can improve its margins and free cash conversion. If Altra can double it to around 8% by 2016 and couple that with mid-single-digit revenue growth, the shares can support a fair value in the mid-$20s. That is a lot to expect of company management, but Altra's strong brand value and specialty niche focus should at least serve to limit some of the downside and makes this an industrial worth keeping an eye on going forward.
Disclosure: I am long SHS.