EnPro Industries Sidestepping Pitfalls

EnPro Industries (AMEX:NPO), maker of industrial machinery, is trying to counter a backstory of misspent youth. It is ending up better than many had expected: management savvy, its global reach and its product diversity are turning around a company with a sad asbestos history.

EnPro manufactures sealing products, metal polymer and filament wound bearings, air compressors and diesel and natural gas-fired engines, among other industry widgetry. It sells in more than 100 countries to customers spanning chemical processing, petroleum refining, food processing, truck making, freight hauling and shipping, power generation and more.

With a breadth of products and geographic expansion, Charlotte, N.C.-based EnPro carved out a sales gain of 11% in 2007 through Dec. 31 to $1 billion. Increased industrial demand from 2006 in the United States and Europe, stronger energy markets and a rise in shipments of diesel engines and parts spurred the revenue rise.

Before asbestos-related expenses and other select items, income in 2007 improved by 26% to $83.8 million, or $3.75 a share, compared with $66.6 million, or $3.09 a share, in 2006. Including asbestos-related costs of $68.4 million in 2007, compared with $359.4 million in 2006, net income was $1.80 per share in 2007, turning around a loss of $7.60.

Asbestos claims remain a grim reminder of the past. The liability of resolving the claims on a rolling 10-year basis is expected near $520 million — an inexact science indeed. Certain experts have broad ranges for costs, and legal fees could add significantly to the expense.

If every family has a black sheep, EnPro was Goodrich Corp.’s (NYSE:GR). Spun off in 2002, it was laden with asbestos claims from its Garlock Sealing Technologies subsidiary, claims alleging injury or death from exposure to asbestos fibers used in sealing products, including gaskets and packing goods. EnPro has ended 900,000 asbestos claims (the first was brought in 1975) and, with insurers, has paid $1.3 billion in settlements.

Despite the asbestos-cost burden, EnPro has been an outstanding investment. Under the leadership of CEO Ernest Schaub, who this month retired and gave way to new CEO Stephen Macadam, the company’s shares have advanced more than 10-fold, to a high last summer of $46.46 from below $5 in 2002.

You’d think that would satisfy any shareholder, but no. Steel Partners II LP, an activist investor, adds one more twist to EnPro’s All-My-Children story: Steel is stamping its feet because it is not getting enough bang for its EnPro stake of 2.4 million shares, or 11.3% of stock.

In a public letter Feb. 19, Steel said the board needed to take steps to immediately enhance shareholder value, adding that concerns were heightened by EnPro’s earnings shortfall and margin deterioration in the fourth quarter.

Steel also has told EnPro to focus on strategic alternatives and assess capital allocations, making clear — among other things — that it believes a share buyback is a better use of money than more acquisitions. A board of directors’ election battle brewed until earlier this month, when EnPro agreed to expand its board to include a Steel appointee. EnPro’s board in March authorized a $100 million share buyback, and — having it both ways — the company concluded an acquisition of a manufacturer of aftermarket products.

Ah, that fourth-quarter pratfall. Margins declined from the previous year period, sales were up 13% but profits declined 3% from 2006. Shares dove 9% on the news in mid-February, to near $29, but have rebounded smartly to close Thursday at $36.28, putting EnPro’s market capitalization at $785 million.

Despite its drama, EnPro has fans. Todd Vencil, analyst at Davenport and Company, in early March maintained a “strong buy” on the buyback and acquisition news. His new 2008 earnings estimate is $4.26, putting shares at a P/E of 9 — well below peers. He has a $50 price target — still just 12 times his 2008 earnings forecast. Vencil says Steel indicated in June 2007, when EnPro was trading near its highs, that it would be interested in buying the company at $47 per share.

Analyst Rob Young at Wm Smith and Company views EnPro positively and carries a price target of $39 — down from a pre-2007 financial release estimate of $45 because of the soft economy. Young wrote that the asbestos issue appears to be in check as the company’s cash flow and cash balance will support expenses above those covered by insurance.

Fundamentals are intact: Young says EnPro’s proprietary products are used mainly for critical applications; about half of EnPro’s business is in replacement parts, which typically have greater margin potential and are less cyclical; and almost half of EnPro’s revenues are international, leading to expected growth in developing regions.

Life is tough on miscreants. But EnPro is sidestepping pitfalls and, as the asbestos claims dwindle, should be able to take the straight and narrow to sustained profitability.

Disclosure: none