What do vending machines, pumps, fiberglass RV panels, and airplane brakes have in common? If you answered "huh?" you win - Crane's (NYSE:CR) many and varied businesses don't always fit together in the most seamless fashion, and the company hasn't really been a model of shareholder value accretion over the years. That said, this is a company with strong market share in many of its businesses and what looks like a renewed focus on margins. Although today's share price doesn't leap out as a bargain, better execution on the new plan(s) could offer some upside.
Mixed News In Q4, With Encouraging Upside
As what amounts to an industrial conglomerate, it was no great surprise that Crane's fourth quarter results were fairly unspectacular. Revenue rose 2% as reported (and on an organic basis), with strong growth in the Merchandising business (up 9%), some growth in Engineered Materials (up 4%) and Aerospace/Electronics (up 2%), and declines in Fluid Handling (down 1%) and Controls (down 7%). All in all, it was a modest miss relative to expectations, with fluid handling and controls being notably weak.
What was more encouraging was the margin performance. Operating income rose 8%, with all segments up on an adjusted basis (led by merchandising's 50%-plus growth). Not only did the merchandising business see the best margins in a decade, but the company's incremental segment margins were incredibly strong - north of 60%, led by merchandising and fluid handling.
Will Merchandising Now Be A Growth Leader?
Crane is the market leader in vending machines in North America (and a significant player in Europe as well), and the company is also active in payment systems (like coin/bill acceptors and dispensers) used in products like the self-service checkout kiosks manufactured by NCR (NYSE:NCR) that you see more and more at retail stores.
That leadership hasn't really translated into huge value, though. Crane has been stuck between its low-growth vending machine business, where replacement cycles run about 10 years absent major industry changes (like legislation), and its higher-margin, higher-growth (but smaller) payment systems business.
That may be about to change. Near the end of the year Crane made its largest-ever deal - paying over $800 million for MEI Conlux, a competitor that is much stronger in payment solutions. Not only was the deal reasonable on its own merits (less than a 10x multiple to trailing EBITDA), but the deal could transform this segment. With MEI, Crane's mix will shift to about three-quarters from payment solutions, a market growing in the mid-to-high single digits. This will not only improve Crane's growth prospects, but the incremental revenue carries higher margins - above and beyond what should be pretty significant synergy benefits from the deal.
Aerospace - Teetering Between Growth And Sequestration
Crane's Aerospace/Electronics business is, like much of Crane, a little convoluted. This segment includes businesses like fluid management and sensors, as well as a sizable aircraft and defense components business. Many of these businesses have strong share (Crane has almost 60% share in aircraft brakes), but fellow aerospace companies like Honeywell (NYSE:HON) have been challenged by a softer aftermarket/parts market as well as the risk that federal spending cuts are going to chew up defense revenue.
On the plus side, the company has a relationship with Boeing (NYSE:BA) that goes back 60 years, as well as relationships with emerging market aircraft OEMs Embraer (NYSE:ERJ) and COMAC. Certainly there's a risk that airlines will cancel orders and/or that build/delivery schedules will slip, but global commercial aerospace demand is growing pretty significantly.
It's also worth noting that this segment serves other markets like chemicals and pharmaceuticals where high utilization is leading to more capex (and more spending on fluid management systems). Last and not least, this is also a highly profitable business for Crane and rivals like Parker Hannifin (NYSE:PH) and Curtiss-Wright (NYSE:CW) generally compete pretty rationally.
Fluid Handling Is An Attractive Market Today
Nearly half of Crane's revenue comes from its fluid handling business, where the company sells a variety of pumps and valves into the chemical, pharmaceutical, energy, industrial, and utility markets. Not only are there a lot of relevant projects moving from drawing boards to shovels around the world, but once an installation uses Crane pumps and valves, they tend to stick with Crane for replacement parts - leading to a long-tail aftermarket business with solid margins.
While Crane has a legitimate presence here, the biggest question for the company isn't so much about further market share growth as it is about better margins on the revenue it has. Relative to rivals like Flowserve (NYSE:FLS), Emerson (NYSE:EMR), and Idex (NYSE:IEX), Crane's history of low-teens margins is not all that impressive. Management is addressing, though, including shifting manufacturing to lower-cost facilities. As the largest revenue contributor, getting the fluid handling running closer to the category leaders is a significant "to do", and one that holds worthwhile upside if management can exceed expectations.
Modest Growth Potential, But Leverage Could Surprise
All told, I would not expect Crane to be a top-line growth leader in the industrial space. The company's engineered materials business (which supplies products like reinforced fiberglass panels to RV makers) could certainly benefit from a turnaround in consumer discretionary spending and the MEI acquisition should boost the growth potential of merchandising, but we're still talking about a business where most of its addressable markets are growing at low-to-mid single-digit rates.
To that end, I expect Crane to grow about 4% over the long term. That compares pretty favorably to its trailing growth rate of 5%, particularly as a sizable portion of that growth was bought in via M&A transactions. By the same token, there's no reason to assume that Crane won't continue to look for deals and bolt-on growth to its underlying organic businesses.
Margins are where Crane could really make or break the investment case. Historically, Crane's returns on capital and free cash flow margins have been pretty mediocre, with both in the single digits and trailing peers. Investors may also not be pleased to see that management shifted its compensation incentives from EVA-based targets to more growth-oriented metrics.
On the other hand, management has openly discussed and addressed its margin opportunities. As mentioned before, management is looking to shift more manufacturing in fluid management to lower-cost facilities. What's more, as of September 2012, management reported at an investment conference that it was running at about 60% capacity - suggesting very significant fixed cost leverage as industrial and aerospace demand improves.
To that end, I give Crane the benefit of the doubt and assume that it will improve its free cash flow margin to the high single-digits by 2017 and into the low double-digits a few years later. That won't make Crane an industry paragon, but it should goose the long-term free cash flow growth rate to nearly 8%.
The Bottom Line
The biggest downside to Crane is that while it has been a bit of a laggard over the past year, it has rebounded pretty strongly since the summer of 2012 (up nearly 50%). With an 8% free cash flow growth rate suggesting a fair value of about $55, there's not a lot of unappreciated upside in the shares. While lower asbestos liabilities, faster/greater margin leverage, and market share growth could all lead to upside, Crane looks priced to perform like a "regular" industrial stock - not the worst thing in the world, but maybe not so compelling when there are other stocks today trading at discounts to fair value.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.