Like so many other industrial names, Crane (NYSE:CR) ended up having a pretty good 2013 from a stock performance perspective. Orders weakened around mid-year, leading to three straight book-to-bills below 1.0, but the Street stayed optimistic on the prospect for better sales in 2014, and the benefits to be had from the MEI acquisition. Not unlike many other companies with exposure to fluid handling and aerospace, Crane doesn't jump out as cheap based upon trailing ratios, though the cash flow picture is a little more encouraging.
Closing The Year On An Okay Note
Crane reported 8% revenue growth for the fourth quarter, with core/organic growth of more than 4%. All of the segments reported growth, with the aerospace and electronics business up 6%, engineered materials up 12%, and fluid handling up 2%. Merchandise systems was up 30% as reported (due to the MEI deal), with organic growth of about 4% despite flat vending results.
The closing of the MEI transaction blurred the reported operating results a bit, but the underlying results were about a penny or two above expectations. Gross margin eased off a bit, while reported operating income rose 16% and segment operating margin improved 80bp.
Orders were perhaps the disappointing part of the report. Orders rose 2% overall, leading to the third straight book-to-bill below 1.0x. I don't want to overplay this, as weak orders haven't been crushing results, but it is a challenge for the company and perhaps a sign of just how much improvement the market is expecting in 2014.
MEI Is A Done Deal
It took about a year from the announcement for Crane to close the deal, but the MEI deal was completed in December of 2013. The deal was delayed due to EU concerns about antitrust, with Crane agreeing to sell the bill-to-bill recycler product line and license the coil recycler to Suzo-Happ. With that, Crane also adjusted the deal price down from $820 million to $804 million.
Now that the deal is done, Crane's Merchant Systems business looks stronger. The company is now much less reliant on the slow-growing vending market and can benefit from the market leverage that MEI will give in cash processing, as well as an expanded low-cost manufacturing base. I do have some near-term concerns about the health of the gaming and retail industries, and these two markets represent about 50% of the market for bill/coin acceptance and dispensing equipment. Over the long term, though, I think Crane will reap some pretty significant benefits from this transaction and I do not believe there is anything structurally wrong with the gaming or retail markets (just a weak point in the cycle).
Aerospace Needs To Pick Up
With strong operating margins (in excess of 20%), improvements in orders and revenue for the aerospace and electronics business is more than just a "nice to have" for Crane. Aftermarket activity seems to be picking up on the basis of what two of Crane's largest competitors, Honeywell (NYSE:HON) and Parker Hannifin (NYSE:PH), reported for their most recent quarters.
Honeywell reported 5% growth in commercial aftermarket sales, and while Parker Hannifin's aerospace sales were down 5% in the quarter due in part to the impact of a joint venture, orders were up 7%. Crane's aerospace sales performance was pretty good (up 5%), but orders for the segment were down more than 4% yoy and down more than 5% sequentially.
I expect Crane to see better sales of original equipment in the coming year. Crane has nearly 60% share in landing systems (brake systems, anti-skid systems and so on) and similar share in sensing and utility systems. With a strong long-term relationship with Boeing (NYSE:BA), Crane should benefit as this company steps up its production.
Fluid Handling - Who Will Be Proven Right?
The stocks of fluid handling companies like Flowserve (NYSE:FLS) and Pentair (NYSE:PNR) have stayed fairly strong, handily beating the S&P 500 over the past year, and industrial analysts seem pretty bullish on demand prospects for the pumps and valves that Crane's fluid handling business sells.
The curious thing is that the analysts who cover the end markets that are supposed to provide that growth aren't as optimistic. Chemicals analysts have been talking a lot more about "restrained" capital spending, while several energy sector analysts have backed away from their expectations of strong project spending over the next year or two. With about half of Crane's fluid handling sales coming from chemical, pharmaceutical, and energy applications, that creates some uncertainty about 2014. Not unlike the potential headwinds in gaming and retail for the payment systems business, I don't think these issues alter the long-term prospects for Crane, but it does represent a risk that estimates for 2014 are too high.
Good Prospects For Long-Term Growth
There are a lot of things that I expect to work in Crane's favor over the coming years. The company is still operating without a lot of unused capacity, and that weighs on margins. I also see further opportunities for the company to shift production to lower-cost locations and improve its cost structure. Considering the order books for the commercial aerospace sector and the engineering firms that build energy infrastructure projects, I am likewise confident that Crane will see an improvement in its sales in the coming years.
All told I'm looking for long-term revenue growth in the mid-single digits, with improved capacity utilization and cost leverage leading to stronger free cash flow growth. Discounted back, I think Crane's fair value is in the high $60s.
The Bottom Line
Although a fair value in the high $60's may not suggest that Crane is all that cheap, to me it means that the company is still priced to offer annual returns that are 20% to 30% better than those of the broader market (or around 10% to 12%). That looks like solid alpha to me, and so while Crane is not the cheapest stock today (and there are some risks to consider in several of its units), it still is no worse than a worthwhile hold to me.
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.