As stated in the company's 10-K, Met Pro (MPR) is a company that was originally incorporated in 1966. It is an industrial manufacturer of recovery pollution control and equipment for purification of air and liquids, fluid handling equipment for corrosive, abrasive and high-temperature liquids, and filtration and purification products.
The company's reportable segments, which give a good idea of the structure, are listed below (again, as reported in the company's 10-K).
Product Recovery/Pollution Control Technologies: This reportable segment consists of one operating segment that manufactures products for the purification of air or liquids. Many of these products are custom designed and engineered to solve a customer's product recovery or pollution control issues. The products are sold worldwide through company sales personnel and a network of manufacturer's representatives. This reporting segment is comprised of the Met Pro Environmental Air Solutions (the combination of the Duall, Systems, Flex-Kleen, Bio-Reaction Industries and Met-Pro Industrial Services product brands), Met Pro Product Recovery/Pollution Control Technologies Inc., and Strobic Air Corporation business units.
Fluid Handling Technologies: This reportable segment consists of one operating segment that manufactures high-quality centrifugal pumps that are suitable for difficult applications, including the pumping of acids, brines, caustics, bleaches, seawater, high-temperature liquids and a wide variety of waste liquids. A variety of pump configurations make these products adaptable to almost any pumping application. These products are sold worldwide through an extensive network of distributors. This reporting segment is comprised of Met-Pro Global Pump Solutions business unit (consisting of the Dean Pump, Fybroc and Sethco product brands).
Mefiag Filtration Technologies: This reportable segment consists of one operating segment that produces filter systems using horizontal disc technology for tough, corrosive applications in the plating, metal finishing and printing industries. These products are sold worldwide through company sales personnel and a network of distributors. This reporting segment is comprised of the Mefiag, Mefiag B.V. and Mefiag (Guangzhou) Filter Systems Ltd. business units.
Filtration/Purification Technologies: This other segment consists of two operating segments that produce the following products: proprietary chemicals for the treatment of municipal drinking water systems and boiler and cooling tower systems; cartridges and filter housings; and filtration products for difficult industrial air and liquid applications. This other segment is comprised of the Keystone Filter and Pristine Water Solutions operating segments.
As the company is engaged in industrial markets it is very well tied to economic growth as whole. Any assumptions stated within are assumed that the overall economy will be in a small growth mode, but not necessarily rapid expansion. The company suffered significant sales contractions going back to over 100M in 2008 and 2009, down to the low to higher 80M range in 2010 and 2011.
The company's margins have varied from the low to mid 30% range over the past 5 years. Some of that is surely volume related, but I also feel they are seeing pricing pressure in the recent history that is impacting them. Based on the last conference call, they seem to be trying very hard to sell themselves as more than just a product, but rather a provider of a solution. Time will tell how successful this is, but surely this is to combat an aggressive product market (at least in some of their markets).
Overall, over the last 5-6 years the company had double digit operating margins in most years (not all), which based on some of the cash flow modeling implies there is some sustainability to the company (to have the revenue decrease so much year over year but still keep almost double digits shows some ability to adjust to the business levels). In the more recent history they are seemingly trying to focus more on the international markets within some of their segments, however I expect that to take time for the benefits to be fully realized. In the most recent year you will see personnel cost increasing as a result of additions for this growth. You could listen to the most recent conference call here.
Revenue - First, let me be clear, I won't pretend to be smart enough to figure out how fast a company will grow. My goal is simply to make an attempt to understand what growth might be needed in order to support a valuation I like. Then I will try to have a feel if that growth level (and other assumptions, such as margins, OPEX levels, CAPEX, DSO, Turns, etc) seems reasonable and obtainable, or not.
All that said I feel MPR is in a strong position to grow in fiscal 2013. They ended with a backlog north of 28M and you would have to go back to Q4 of fiscal '07 to find a year-end position better than this. And how did it work out in 2008 after ending 2007 with such a high backlog? Well, the company managed to grow their revenue above 15% in the year following.
In addition to the historical comparisons, it helps the company announced the largest order in its history, to add to the already impressive backlog and order entry trend. In general, the company doesn't take more than a year to work off backlog, and from all indications they can usually turn orders into revenue in 6 months or less. I found the trend for the next quarter to be relatively sporadic when comparing ending backlog vs. next quarter revenue (Next quarter revenue ranged from in the 70% to over 100%, as compared to the beginning backlog of the period).
The trend vs. the next 6 months however, seemed to range between 40-60%. Taking all of this into account, it wouldn't be surprising for me to see them do $113 to $118M in sales for 2013. Based on that analysis and as long as there is not a significant change in the economy, I would be comfortable modeling 12-15% growth for the next year, then modulating this down over the next 3-5 years (not taking into account significant acquisitions).
Gross Margins - The company seems to be trying to transform itself into an engineering solutions model…which I take to mean, they want to be selling more than just a "box", they want to be selling a solution. I would imagine this is to help combat against strong price competition and to help differentiate themselves vs. the competition. I think the margins will have some benefit if the revenue can grow in the double digits as the company covers its fixed cost in the COGS area. However, I also think this can be offset by 1.) Significant price competition in existing markets and 2.) Price concessions as the company tries to enter new markets.
OPEX - The company has typically been above 20%, as a percent of revenue, for their OPEX. In fact, in the more recent years it has been between 24-26% (even adjusting for severance). I expect that while the company will have some nominal increase in OPEX, it will not exceed the level of sales growth, at least in the very near term (next two years). As such, I am including OPEX at 24.5% down to 24% 5 years out. I think the company could be more aggressive on its cost structure and part of this may be to sell off the divisions that don't have much international presence, are small, and seem to lack growth (Pristine water solutions, as an example).
Working capital - Until a few years ago the company had DSO in the range of 75 days or so, but starting a couple years ago the company has been able to improve this figure to around 60 days. I haven't been able to find any specific reason for the improvement, but these things can vary based on customer mix, business segment mix, country mix, etc. I am assuming that as they try to get more business in new markets (and international markets in general) it could cause some upward pressure on the DSO, and have modeled it in the 64-66 range. It should be remembered the product recovery and fluid handling, especially to the extent they win larger products, are likely to take more working capital commitment. Additionally, based on the overall objective of selling more of an engineering solution, this could cause more of a working capital investment (if it ties longer approval cycles to an entire project, as an example).
As to the turns, I don't have any particular insight here, other than to note the company has been in the range 3 to 3.9 consistently. I would be very hesitant to show significant improvement, particularly if the nature of making them more of an engineering services/solutions provider would cause more of the inventory to be tied to various levels of project acceptance (could require that the fund the inventory a bit longer before being allowed to bill), but I wouldn't see of a reason to show significant decline either.
CAPEX - I am going to model an increase in the CAPEX to around 2.5M per year over the near future as the company tries to expand in the international markets. Based on the cash levels being where they are (all time high) I suspect the company will make some type of acquisition. At this point, it is uncertain what that may be, but I would largely prefer organic growth to a potential wasteful acquisition.
Valuation and Risk
Valuation - In order to build a valuation, I use some near term assumptions on the financials (based mostly on the above), then assume a terminal value 5 years out based on various multiple-based approaches (Price-to-book, Price-to-Sales, Price-to-Earnings, Price-to-Operating Income). I used in this case both a dividend discount model and a free cash flow model, for the five year projected cash flows. As well, I have a range of discount rates, but have primarily focused on the 12% data point.
So what does all that mean? In short, I have used 1 primary source of financial assumptions in terms of what the company will do, but have used multiple approaches in terms of what price we should pay for the cash flows generated by the company. Based on all this, I would be targeting a valuation range of about 9.5 to 12 per share. I would probably consider adding at under 9.00 per share.
There are risk inherent in both the analysis I have done as well as the company/market in general. While these certainly aren't all of them, from my perspective they include:
- In the past, the company did have some internal control issues, which caused it to re-state its financial statements.
- Recent personnel turnover (CFO) could be cause for concern.
- The company has record levels of cash and could potentially make a destructive acquisition. I would prefer to see a one-time dividend and for them to increase the pace of dividend increases.
- I believe the company should look to sell off the smaller operating companies with no international presence and that don't seem to be able to be leveraged to the overall structure (again, Pristine Water)
- The company is tied to the overall economy and as such could be significantly impacted by a large economic contraction
- All the assumptions I included could provide to be significantly wrong from what actually happens, which would materially alter the valuation.
Disclosure: I am long MPR. All else equal, I would likely be adding at under $9 per share.