Manitowoc (MTW) is an odd industrial company, as it combines a fairly steady food service equipment business with a leading (but extremely cyclical) crane business. Counting on the future to be just like the past is admittedly dangerous, but if Manitowoc's crane business follows pretty consistent historical patterns, investors may have several more years of improving sales and cash flow to look forward to, as well as an undervalued stock.
Food Service - Smaller, But Usually More Profitable
Although the crane business produces more revenue for Manitowoc, the food service business is both more consistent and generally more profitable across a full cycle. For better or worse, this is a story unlikely to produce a lot of surprises either good or bad.
Manitowoc has built a good franchise balanced between cooking/warming and ice/refrigeration products, with additional offerings in prep, service, and storage. With more than half of the company's sales in replacement equipment and 40% going to the quick-service restaurant market, Manitowoc is in good shape to take advantage of the ongoing trends of more and more meals being eaten outside of the home and more of those meals being eaten at QSRs like McDonalds (MCD) or Subway.
If there are vulnerabilities to this business, they may be in its under-penetration in emerging markets and the risk of under-investing in innovation. Looking at the growth of companies like Yum Brands (YUM) and Starbucks (SBUX) in China or Arcos Dorados (ARCO) in Latin America, it's not hard to see where the real long-term growth opportunities lie. While large customers tend to take their suppliers with them overseas, there's still unexploited potential in Latin America and Asia for Manitowoc.
As far as innovation goes, that's an admittedly subjective complaint. Manitowoc, as well as large rivals like Illinois Tool Works (ITW) and Dover (DOV), don't necessarily look as dynamic as a smaller pure-play like Middleby (MIDD) or Standex (SDI) but some of that has to do with the scale of the respective businesses; a single new product (or, more commonly, newly acquired product) at Middleby simply makes a bigger difference to the sales base.
Cranes Coming On
Making up 60% of 2011 sales, Manitowoc's crane operations are certainly larger than the food service business and the incremental margin potential is likewise considerably larger. Unfortunately, this is a business that can be pretty profitable in good times (15% operating margins), but undergoes devastating declines in bad times (tower crane sales can fall more than 80% from peak to trough).
Right now, though, business is looking up as energy projects stack up around the world and developing countries continue to spend large sums on infrastructure improvements. Although the North American construction market has been slow to recover, it looks as though the worst may be over.
Manitowoc certainly has plenty at stake. Unlike Caterpillar (CAT), CNH, or even Terex (TEX), Manitowoc is highly concentrated in what it has to offer the construction market - while it sells a variety of cranes (lattice-boom, tower, mobile telescopic, and boom trucks), that's all it has to sell. So while Caterpillar can rely on a very diverse array of machinery and Terex can look to its aerial work platform business to supplement growth, Manitowoc is committed to these very high ASP products.
Manitowoc's end-user markets are pretty diverse, with commercial construction being the largest individual market, but other markets like energy, utilities and infrastructure making up sizable percentages as well. Commercial construction has admittedly been weak in North America and Western Europe (Manitowoc's largest markets), but energy infrastructure projects like terminals, pipelines and platforms have helped take up some of the slack.
Recent ABI readings have been positive and may be pointing at a gradual recovery in commercial building activity in the United States. Again, it is wise to emphasize "gradual", but four consecutive readings above 50 seems like more than just happenstance. There may also be a long-term domestic infrastructure story to support the crane business; while federal and state budgets are not in great shape, sooner or later roads, bridges, dams and the like need to be repaired or replaced and that's going to take heavy machinery like cranes.
How Many Years Left In This Crane Cycle?
The last two up-cycles for Manitowoc have both lasted about five and a half years. Depending on what you choose as the starting point, then, Manitowoc should see another peak between 2014 and 2016. In the last cycle, crane revenue peaked at nearly $4 billion, and margins peaked at close to 15%. By way of comparison, 2011 saw $2.2 billion in sales, and fourth-quarter orders annualized to $2.7 billion. It's not hard to see that there could be a lot of incremental earnings and cash flow yet to come down the road.
That said, this cycle is likely to be a little different and Manitowoc is going to need to do better in international markets to really hit that potential. Luckily, it looks like that's going to happen - the company is building facilities in Brazil and specifically targeting markets like India and Indonesia as priorities.
At the same time, Manitowoc's competition is hardly resting. Terex, too, is looking to increase its leverage to emerging markets. Manitowoc also may need to worry about competitors undermining its long-held core markets. China's Sany is looking to grow its North American business and building a plant in Georgia, certainly a sign that it's serious about it. Likewise, Liebherr, Sumitomo, XCMG, and Zoomlion would all be more than happy to fill in any gaps that Manitowoc happens to leave.
The Bottom Line
Manitowoc's highly leveraged balance sheet certainly limits the company's options when it comes to buying growth or being generous in returning capital to shareholders. While I'd be far more concerned about that debt load at the top of a cycle, management should have the opportunity to pay a lot of that down if the crane cycle follows the same basic path as it did leading up to 1991, 2000, or 2008.
Modeling Manitowoc's cash flow is no picnic, as it seems very likely that free cash flow will peak at some point in the next five years, trough in the next five years afterwards, and climb back up again. For the next five years, I believe free cash flow can grow in the low teens relative to the company's full-cycle average and that sort of growth can support a fair value in the high teens.
Admittedly that's not huge appreciation potential (and there's a more uncertainty to those numbers than for most companies), but relative to Caterpillar, CNH, and even Terex, Manitowoc could still have a lot left in the tank for investors looking to play international development and an emergent recovery in U.S. commercial construction.