Altra Industrial Motion (AIMC) announced another acquisition, boosting its presence in Europe. The bolt-on deal of Stromag seems fair but increases leverage quite a bit at a time when the core continues to be challenged.
The deal looks decent, particularly on the back of the synergy estimates, yet real upside can only be seen once end markets recover and margins expand. I see $40 per share being attainable if end markets recover in a year or two, but I refrain from jumping aboard as shares have priced in quite some good news already throughout 2016.
Who Is Altra?
Altra designs and produces mechanical power transmission (MPT) components. These are used to control and transmit power in industrial applications across the world. Major clients of Altra can be found in energy, general industrial, metals mining, machinery, transportation and turf & garden industries, among others.
The company has subdivided its activities in three segments. Couplings, clutches & brakes make up nearly half of total sales. The electromagnetic clutches & brakes division and gearing division each makes up roughly a quarter of sales.
Given the critical function which these products provide in the process, as downtime costs are often high, quality and reliability are critical. The industrial power transmission business is very large, totaling roughly $35 billion in the US alone. The market continues to be very fragmented as Altra aims to play a consolidating role in this.
The company has announced numerous acquisitions in recent years including the $15 million purchase of Guardian, the $103 million acquisition of Svendborg and the $69 million deal to acquire Bauer, among others.
Despite the acquisitions made in recent years, Altra has not seen that much growth. Revenues grew from $675 million in 2011 to a peak of $820 million in 2014, before falling back to $747 million in 2015. Revenue growth is very modest as the company spent quite a bit on acquisitions in recent years.
Operating margins peaked at 10-11% of sales in 2011, 2012 and 2013 before they started to come down. Margins fell to 9% in 2014 and 8.5% in 2015 on the back of challenging end markets, notably in mining and the oil & gas sector as the strong dollar had an impact as well.
These headwinds continued in 2016. Third-quarter sales were down by 5.4% on the back of a 3.9% organic decline in sales. The good news is that sales declines were less pronounced compared to the first half of the year. Third-quarter operating margins fell to just 6% on the back of additional restructuring charges, having fallen to just 8% if we generously exclude restructuring costs.
The company guides for revenues of $710 million this year, GAAP earnings of $1.25-1.30 per share, and non-GAAP earnings of $1.45-1.50 per share. The twenty cent discrepancy between both earnings metrics is largely the result of restructuring charges, legal fees and M&A-related costs.
The company ended the quarter with $40 million in cash and $216 million in debt. This $176 million net debt load excludes pension-related liabilities of roughly $9 million. The 26 million shares trade at $29 each, for a market valuation of roughly $750 million, giving Altra a $920 million enterprise valuation. That is equivalent to 1.3 times sales. Based on reported adjusted EBITDA of $101 million, the business is valued at 9.2 times EBITDA.
Adding More Debt, Another Deal
Altra is further expanding its operations into Europe with the purchase of Stromag, a German producer of clutches and brakes, among others. The company generates three quarters of its revenues in Europe, including a large renewable customer base.
The EUR 184 million deal tag increases towards EUR 198 million, if one includes the debt being assumed by Altra. With the deal, Altra is boosting its business with EUR 131 million in sales, for a 1.5 times sales multiple. EBITDA generated by Stromag amounts to EUR 20 million a year, for a 10 times multiple.
Accretion is expected to 2017's earnings, but that is not really a qualification in this low interest rate world, nor has accretion been quantified. Cost savings can be achieved through shares production and sales efforts, anticipated to reduce costs by EUR 5-7 million per year. Including synergies, EBITDA might improve towards EUR 26 million a year, for a 7.6 times multiple.
Pro-forma EBITDA now runs at $124 million or roughly $130 million including synergies. The pro-forma net debt load will more than double to $400 million. That suggests that leverage ratios will come in at around 3.1 times, being fairly elevated.
Assuming that the $1.50 non-GAAP earnings multiple is sustainable going forwards for Altra in this environment, we have to estimate the expected contribution from Stromag. If we assume a similar 8% operating margin, operating earnings from Altra might come in at EUR 10 million. The financing costs on the EUR 200 million deal will eat most of these operating earnings.
The EUR 6 million in pre-tax synergies could result in a EUR 4 million after-tax earnings contribution, adding $0.15-0.20 per share once synergies are realized. More accretion set to occur once financing costs come down, as the balance sheet gets less leveraged over time.
Fully Valued For Now
The multiples paid for Stromag make sense as Altra makes a nice timing move in terms of foreign exchange, buying at a time when the dollar is very strong again versus the euro. Altra is getting quite leveraged, yet depreciation & amortization charges surpass regular capital spending requirements by quite a bit, allowing for deleveraging of the balance sheet.
If we assume 10-12% margins going forward once end markets recover in the coming years, while revenues could grow towards $900 to $1 billion, operating profits might reach $100 million in a couple of years. After taking into account $15-20 million in interest expenses and 30% tax rates, earnings come in at $55-60 million, for earnings of $2.10-2.30 per share.
A market multiple could value shares at $40 in such a case, leaving compelling 30-40% upside from today's levels, but that requires time, a recovery of end markets and some real efforts from management as well.
You get the point, shares of Altra are fairly valued already as they have risen 15% so far in 2016, despite the fact that revenues and earnings continue to fall amidst challenging end markets. The Stromag deal seems fair but is not a major value-creating move, while it adds quite a lot to the leverage position.
Until real benefits are seen in the coming quarters in terms of a recovery of end markets, or shares retreat from the current levels in the high-twenties, I would not be a buyer of the shares.
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.