Timken Has Immediate 40% Upside, Longer-Term 100% Upside Potential

Summary

• Timken reported a great quarter early Wednesday morning.
• The company has raised its guide for next year - the second time in as many months to raise FY guidance - to $3.90.
• TKR is a rock solid century old dividend payer that deserves a P/E of 15 and short-term share price appreciation of about 40%.
• TKR 2018 estimates have gone from $3-$3.90 in five months and in the same time shares are lower by 20%, trading with a P/E of about 10 - insanely cheap.

Timken (NYSE:TKR) was out with earnings this morning that punched out the Street's expectations, posting EPS of $1.02 vs. estimates of $0.87 and revenue of $883.1 million, which beat by over $40 million. The company also upped its guidance for the upcoming year - the second time it has raised guidance in as many months - and Timken now expects 2018 GAAP earnings per diluted share of $3.80 to $3.90 and adjusted earnings per diluted share of $3.90 to $4.00.

The stock hardly responding in trading, making it still cheap considering the fact that the company was trading closer to $50 before the recent market volatility and before it raised guidance twice. Since January, the company's 2018 EPS estimates have gone from $3.00 to $3.30, then to $3.60, to now being $3.90-$4.00. In the same time period, the stock is down almost 20%. Timken is now officially a bargain.

Based on the company's new guidance and a P/E of 15 (which is still quite conservative, considering many century old dividend paying blue chips are priced at P/E's of 20 and above in this market), Timken shares could have short term 40% upside and even further upside over the longer term. It's also worth noting that TKR's are fully diluted GAAP numbers, so there's little to no room to be "turning knobs to change EPS," as Ubiquti Network's CEO once put it.

The company stated in its press release that it had a positive Q1 due to organic growth, acquisitions and FX tailwinds:

The increase was driven by strong organic growth across most end-market sectors led by industrial distribution and off-highway, as well as the benefit of acquisitions and currency.

They also had benefits from lower pension related charges and a favorable tax rate:

In the first quarter, Timken posted net income of $80.2 million or $1.02 per diluted share, versus net income of $38.2 million or $0.48 per diluted share for the same period a year ago. In the current quarter, the company benefited from higher volume, favorable price/mix and manufacturing performance, and the impact of acquisitions, which were partially offset by higher selling, general and administrative (SG&A) and logistics costs. The current quarter also reflects lower pension-related charges and a lower tax rate.

The company also made the bold statement that it is outgrowing its markets in its press release (emphasis added):

'We achieved excellent first-quarter results, reporting strong revenue and earnings growth with expanded margins,' said Richard G. Kyle, Timken president and chief executive officer. 'Over the last several years, we have grown our portfolio organically and through acquisition, expanded our geographic reach and improved our cost structure. As a result of these strategic actions, we are winning with our customers and outgrowing our markets.'

The company commentary on guidance sounded equally as bullish:

'We are raising our outlook for the year as a result of the momentum we are seeing in our end markets and our confidence in our ability to execute,' said Kyle. 'As we continue to advance our strategy and stay focused on creating customer value, Timken is positioned to reach new levels of performance in 2018.'

These numbers were right on the money and exactly what I was looking for. It was a strong quarter that reaffirmed my previous article on TKR, stating that I thought the company was significantly undervalued. In my recent, longer article on TKR, I predicted that the company could get acquired itself if it stays as cheap as it is. With its raised guidance and the stock still in the mid $40 range, the company remains cheap. In that article, I came up with a range of price targets between $56 and $86, using old estimates of $3.50 for 2018 and $3.95 for 2019. These will need to be revised higher. Assuming next year's estimates also come up about 10% and applying a P/E of 20 to these numbers means the stock could easily double over the longer term.

Valuing the company at about 15 times its new earnings estimates for next year gives us a target price much closer to $60, where I think the stock can and should trade based on this quarter's report and raised guidance. As I said in my first article about TKR, it works in an unsexy business: ball bearings. Because this is an industrial business, the company is not given a premium multiple, however a 15 multiple is not unheard of for even a conservative dividend paying industrial company like TKR.

I continue to believe that the company's product and its management give it staying power. TKR's product is backed by an intangible that cannot be easily replicated or duplicated. The company's long-standing track record of reliability and safety is something its customers look for when lives are on the line. This can't be easily duplicated or replicated by new entrants to the industry and that is a part of what makes TKR's products so unique.

Management has also proven itself to be strong leaders. They have executed on a multiple year restructuring effort that is just now starting to bear fruit. They have made prudent capital investments overseas to expand the company's footprint globally, with recent expansions and acquisitions made in Europe. On top of that, management is committed to delivering shareholder value and is confident at the job they're doing. I believe TKR management could be the exact type of managers Buffett likes to simply "let run their company" while he is invested.

Here's an updated "shareholder friendliness" chart that I just love:

TKR Shares Outstanding data by YCharts

Timken still has significant growth opportunities ahead of it, as I pointed out in my first article. Timken is striving to move more into mechanical power transmissions in the future, a move that would significantly expand the company's total addressable market, compared to the bearing market, which makes up about three-fourths of the company's total sales right now. The company's size versus the potential expansion in TAM in the below chart shows how much true opportunity for growth there is for TKR over the long term.

Over the course of the longer term, depending on multiple expansion scenarios and how the company performs, I still see potentially more upside than 40% for TKR for those who are patient and are willing to wait.

To conclude, I am reaffirming the conclusions I drew in my previous article about TKR. The company is performing well financially, has a history that's a century old of paying dividends and is buying back stock. It is a shareholder friendly company led by a management team that has proven that they can execute. It works in a relatively unsexy business that is just boring enough to be something that slips under the radar, yet could be of interest to somebody like Berkshire Hathaway, as I argued in my previous article.

TKR continues to be one of my favorite longs and my short-term target price target for this year is $60. From there, I will reassess the company's financial performance throughout the course of the year and determine what my longer-term targets could be.

Analyst’s Disclosure: I am/we are long TKR. 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.