On March 9, pump designer, maker and seller Gorman-Rupp (NYSEMKT: NYSE:GRC) came out with its annual 10-k for 2014, which follows up on its earnings announcement released Feb. 6. The company did well in 2014, and its balance sheet remains in good shape. Let's take a look to see what's going on with Gorman-Rupp.
In 2014, Gorman-Rupp saw its revenue and net income increase 11% and 20% respectively. However, the company saw its free cash flow decline 49% last year. The company still sits on an ok balance sheet. Gorman-Rupp's $24.5 million in cash equated to 9% of its stockholder's equity in 2014 vs. $31.1 million in 2013 or 12% of stockholder's equity. I always prefer to see companies harbor cash/investments equating to 20% or more of stockholder's equity to help them through tough times. In counterbalance the company possesses no long-term debt to siphon off cash in the form of interest expense.
What drove the numbers?
A large part of Gorman-Rupp's increase in revenue came from increasing demand. This is something that any publicly traded business owner wants to see. It means that customers increasingly want, or need, your product which beats seeing growth merely as a result of acquisitions which can give an artificial boost to revenue and profitability. Gorman-Rupp did make new acquisitions in 2014. The acquisition of the Bayou City Pump Company contributed $8.5 million, or 20% of its overall revenue increase. Infrastructure projects meant to curtail flooding such as the Permanent Canal Closure in New Orleans and dewatering needs pertaining to fracking and oil drilling also drove top line results. Record demand volume caused revenue growth to outpace the growth in net income causing expanding margins.
The decline in free cash flow came mostly from timing in the collection of customer payments, deferred revenue and accruals. Inventories also made an impact on free cash flow. Capital expenditures actually declined 37% serving as a buffer against further free cash flow decline.
It's worth noting that Gorman-Rupp is a dividend aristocrat. In Oct. 2014, Gorman-Rupp increased its dividend 11% representing 42 years of consecutive dividend increases. Dividend sustainability can be measured by comparing the total dividend payout to a company's free cash flow. I like to see companies pay out less than 50% of their free cash flow in dividends retaining the rest for other uses.
In 2014, Gorman-Rupp paid out 59% of its free cash flow in dividends, which resides a little above my personal threshold, due to the decline in its free cash flow. In 2013, the company paid out 27% of its free cash flow in dividends. Currently, the company pays its shareholders $0.40 per share per year translating into an annual yield of 1.4%.
Thoughts on the future
Increasing infrastructure upgrades and agricultural needs here in the United States and across the globe will serve as long-term catalysts for fundamental growth translating into superior capital gains and dividend increases. However, in the more intermediate term the strengthening dollar and falling oil prices will serve as a drag on Gorman-Rupp's fundamentals as petroleum companies scale back on operations which include dewatering processes.
Should I buy?
Wall Street has acknowledged Gorman-Rupp's possible headwinds by assigning it a P/E ratio of 21 vs. its five year average of 24, according to Morningstar. This still makes it overvalued relative to the S&P 500 which has a P/E ratio of 20. However, on a forward basis the company is slightly undervalued trading at a P/E ratio of 18 vs. 19 for the S&P 500.
Investors may want to take a small position in Gorman-Rupp while expecting some volatility over the next three years due to the issues mentioned above. They also may want to take advantage of any price corrections and buy on the dips. In essence, I'm cautiously bullish.