Will A Change At The Top Shift Sauer-Danfoss's Trajectory?

Aug.30.12 | About: Sauer-Danfoss Inc. (SHS)

It has been a few months since I last wrote on small industrial company Sauer-Danfoss (NYSE:SHS), and the interim has not been especially kind to the company. With large exposures to China and Europe, but without the same breadth of products and depth of customer relationships, Sauer-Danfoss has seen a much larger setback in revenue and profits than larger rivals like Eaton (NYSE:ETN) and Parker Hannifin (NYSE:PH) and OEMs like Caterpillar (NYSE:CAT) or Deere (NYSE:DE).

Waiting for a turnaround in Europe and Asia was going to be trying enough, but now investors have a new concern to chew on -- the company announced this morning that CEO Sven Ruder will resign in October and hand over the job to newly-hired Eric Alstrom.

A Sign Of Trouble … Or A Natural Progression?

Apart from well-telegraphed CEO successions, a change in the top kick is always at least a little turbulent for a company. Mr. Ruder did a fine job as CEO of Sauer-Danfoss, coming over from majority shareholder Danfoss A/S early in 2009 and leading the company through a very difficult period (the post-housing crash recession) that saw these shares trade into the low single-digits.

Now he is handing over the reins to Eric Alstrom, a young (46 years of age) executive who comes to Sauer-Danfoss from Benteler - a large German auto parts and components company with roughly $8 billion in sales.

This is a curious move on multiple levels. Ruder is not that old (55 as of the last proxy), and could have done a great deal more. Whether he intends to go on to an early retirement, back to Danfoss A/S, or take another position at a different company, I have no idea. But at least from the standpoint of turning around the company, I believe investors can say "job well done".

As for the new CEO, Mr. Alstrom's experience in the automotive industry does not necessarily speak to deep knowledge about a company that sells components for off-highway equipment like dozers, wheel loaders, and combines, but you can't always judge a book by its cover. After all, Mr. Ruder's academic background included a B.A. in Hispanic Studies -- not exactly a traditional background for an industrial company CEO. What's more, with his relative youth and external perspective on the company, Mr. Alstrom could turn out to be a solid choice for a company that needs to start thinking about building its future.

Strap In For A Rocky 2012/2013

While the quality of a CEO has a lot to do with a company's long-term performance, the short-term performance at Sauer-Danfoss is likely to remain pressured. Performance has continued to erode on a quarterly basis, with the last quarter seeing a 3% constant currency decline in sales, an 18% decline in operating income, and a 12% sequential drop in orders.

Worse still, there's no reason to expect an immediate improvement. Major OEMs like Caterpillar, Deere, and CNH (NYSE:CNH) have all reported seeing declining end-market strength, and core markets like Germany and China could very well get worse before they get better. Along those lines, reports that Chinese construction equipment companies Sany and Zoomlion have sizable inventory in dealer channels is worrisome.

There's another curious aspect of Sauer-Danfoss's performance that's worth keeping in mind. For reasons that presently escape me, this company seems to have a track record over recent years of not only being something of a leading indicator, but also experiencing new trends with greater intensity. Iin other words, when things were good, they were very good, and likewise, conditions here have gotten meaningfully worse than at many comparables. I'm keenly interested in seeing if that leading trend holds up -- if the next quarter is incrementally better, that might be an encouraging bit of news for investors looking at a larger range of industrial companies.

The Bottom Line

There is basically no analyst coverage on Sauer-Danfoss, which leaves investors largely fending for themselves in terms of expectations. Though I mean no disrespect towards the Value Line analyst who covers this stock, I think his numbers on Sauer-Danfoss are too aggressive, and I think investors ought to keep a more conservative outlook in mind. To that end, I think the company will do well to post $1.9 billion in fiscal 2012 revenue and probably won't be much beyond $2.4 billion in five years' time.

I may well be too conservative with those numbers, but the good news is that I don't have to be aggressive. Provided that Sauer-Danfoss can hold on to its margins from here and continue to post double-digit free cash flow margins, even weak forward free cash flow growth (below 5%) is sufficient to drive a fair value beyond $60 and provide ample funds for dividends, buybacks, and/or acquisitions. It's also worth noting that Danfoss A/S could have another go and buy out the remainder of this company at some point.

These are unquestionably tougher times for Sauer-Danfoss, and new leadership adds to that risk. While I do feel foolish for not selling these shares before when they exceeded $55, they haven't done that bad relative to Caterpillar, Deere, or Joy Global, and I'm content to hold on for better days.

Disclosure: I am long SHS. 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.