It has been an interesting decade for SPX (SPW), as the company has gone through spasms of acquisition and divestiture but really hasn't set the world on fire with its margins, returns on capital, or free cash flow generation. With most of the business shuffling complete, and broadly improving utility demand, can SPX show that it deserves a spot on a list of quality industrial conglomerates?
Will Macro Worries Weigh On 2013 Optimism?
After several years of underperformance, investors have been looking to 2013 as a year of recovery and improvement for SPX. The question I have, though, is whether macroeconomic issues are going to cloud this sunny outlook.
SPX gets more than 40% of its revenue from power generation customers. As one of the market leaders in transformers, alongside ABB (ABB) and General Electric (GE), SPX should be seeing better demand for medium-sized transformers in the near term and better demand for larger transformers in the coming years. Unfortunately, the power markets have shown themselves to be quirky and difficult to predict, as several erratic reports from ABB, Siemens (SI), and GE would support.
Perhaps part of the issue is that power generators still can't be too sure what sort of market they're building or budgeting for in the future. Nuclear power has seen its future dim considerably in the last year or two, and so too (to a lesser extent) for coal; a problem for SPX as it is a leading manufacturer of cooling towers for these plants. On the other side, governments have backed away from rich subsidies for renewable power generation and the transmission/distribution in many countries simply isn't up to snuff anymore (whether due to age or increasing consumption/demand).
Is It Cyclical Or Structural?
The bulls on SPX hold to the idea that the company is an industrial conglomerate leveraged to late-cycle sectors and that margins/results are cyclically depressed. If that thesis holds up, the thermal and transformer businesses will perk up on utility demand and the flow control business will prove to be more sustainable. At the same time, the company's asset sales should enable management to meaningfully reduce its debt burden and/or continue to repurchase shares (the share count has dropped by about 40% over the last decade).
Ostensibly, that should work out. ABB, GE, and Siemens have all been pretty enthusiastic about the global thermal power and T&D markets, even if they haven't been as predictable or reliable as they might like. Likewise, I like the company's sanitary food/beverage business (part of flow technology), as companies like Nestle (NSRGY.PK) and PepsiCo (PEP) continue to grow their dairy businesses around the world.
But I still have some doubts. Although the company's flow control business has been a reliable performer with double-digit segment margins, performance in the thermal and industrial groups (where the company faces the likes of ABB, GE, and Siemens) has been considerably more erratic. If it comes down to execution, then, I do trust SPX to continue to do well against the likes of Alfa Laval, GEA, and Flowserve (FLS) in flow technologies, but I'm not so sure about the other businesses. By the same token, if those end markets in power fail to grow as expected over the next couple of years, I like the expense structure of ABB and GE better.
The Bottom Line
I liked ABB enough that I bought the shares for my own account, and I do believe the company's positions in automation and power are appealing for the long term. I also can see arguments for bullishness on GE, Siemens, and Honeywell (HON) among other industrial conglomerates. I have a harder time saying the same for SPX, even though I do think management has restructured the business along logical lines and should be in position to benefit from global utility expansion.
Even with an assumption of double-digit free cash flow growth for a decade and sustained free cash flow margins in the mid-to-high single digits (something that the company has not done over the past decade), the stock still isn't particularly cheap. So although these shares have done quite well over the last year, I think a lot of the optimism on the power market is already in the shares and investors can do better in cheap industrial names.
Disclosure: I am long ABB.