Columbus McKinnon (NASDAQ:CMCO) is a bit of a puzzler to me now. Despite racking up multiple quarterly EBITDA beats in a row and eight quarters of year-over-year gross margin improvement, the shares are about 15% lower than they were last time I wrote about this leading player in material handling, and that was closer to down 25% before a big post-earnings reaction. Granted, industrials haven't done so well over that same period, and there are valid concerns about slowing end-market demand, but I'm still surprised the improvements in the business aren't being better reflected in the share price.
More than a third of Columbus McKinnon's revenue comes from end-markets/sectors that I'm concerned about today, but the company is gaining share and management expects another four points or so of EBITDA margin improvement from fiscal Q4'19 levels. With increased R&D spending going towards automation-enabling product development and my expectation of low-to-mid single-digit long-term revenue growth, mid-single-digit FCF growth, and low-double-digit ROIC, I believe these shares offer meaningful upside even with the risk of a sharper near-term slowdown in the business.
Another Strong Quarter Despite A More Challenging Backdrop
The March quarter saw a definite slowdown in many industrial businesses, but Columbus McKinnon nevertheless came in with a solid result that reflected ongoing share gains and benefits from restructuring efforts.
Revenue rose a little more than 7% in organic terms, with U.S. revenue up about 10% on an adjusted basis and overseas revenue (generated mostly in Europe) up about 4%. Impressive to me was the 5.5% volume increase in the quarter - a level of volume growth that I believe reflects share gains and addressable market expansion.
Gross margin rose about 20bp on a reported basis and more like a point on an adjusted basis, continuing an impressive run of improvements driven by lean manufacturing, supply chain optimization, improved product design, and divestitures of lower-margin businesses. Adjusted EBITDA rose 12% in the quarter, while adjusted operating income jumped 24%, with operating margin improving about two points. Columbus McKinnon isn't widely covered, but these results were good for a roughly 3% beat at the top line, a 70bp beat at the gross margin line (adjusted), a 7% beat at EBITDA, and a double-digit beat at the operating income line.
About Those Challenges…
Although the company had another strong quarter and this isn't a business with particularly large backlogs or long order fulfillment timelines, there are definitely signs of a slowdown in the business. Order growth has decelerated from the low double digits in the September quarter to 5% in the December quarter and just 1% this quarter. Likewise, the backlog has gone from high-single-digit growth to mid-single-digit growth and now contraction (down 3%) this quarter. Even so, management's guidance for the next quarter was in line with expectations, with organic revenue growth of around 3%.
Metal processing is a significant end-market for Columbus McKinnon, steel in particular, and steel capacity utilization is still strong despite ongoing weakness in prices. What's more, and I believe more relevant to CMCO's growth outlook, companies like Nucor (NUE) and Steel Dynamics (STLD) continue to move ahead with capacity expansion projects that mean more demand for hoists, cranes, power control, and chain products.
Oil/gas also looks healthy for the company, with a strong pipeline in both midstream and downstream segments and signs of improving offshore demand. The chemical/petrochemical end-market is also healthy, and I think the strong order books at companies like Emerson (EMR) and Honeywell (HON) bode well for the next three to five years, though this is a sub-10% segment for the company.
Now the "but's". Management didn't comment specifically on autos (a 10% market) beyond acknowledging sales were down, but the same near-term weakness impacting companies like Rockwell (ROK) on the automation side is going to hit CMCO in terms of spending on capital equipment. I'm also concerned that oil/gas spending could be peaking, though that's more at the upstream level where CMCO is less exposed. I'm also increasingly concerned about the "general industrial" market, as multiple multi-industrials have warned about slowing demand trends and distributors like Fastenal (FAST) report slowing momentum.
More Self-Help Opportunities
Columbus McKinnon is in the early part of Stage II (of three) of its restructuring/transformation process. The company has disposed of $40 million in revenue of lower-margin/non-strategic business (including its tire shredder business) and continues to leverage efforts to reduce labor and material costs while also improving delivery times and building out its higher-margin engineered-to-order offerings. With that, management raised its fiscal 2021 EBITDA margin target from 15-17% to 19% a couple of quarters ago, which suggests significant margin improvement potential from here.
When the company transitions to Phase III, it will include further portfolio optimization and select acquisitions. To that latter point, I expect CMCO to target deals like Magnetek - deals for products/technologies that enhance CMCO's participation in/leverage to factory automation.
There's still an important DIY element to that, though, too. CMCO's new Smart Hoists include capabilities like remote monitoring, precision lifting, and load sensing, as well as predictive maintenance, and the company has already seen some returns on its decision to increase R&D spending; fiscal 2019 R&D spending was similar to 2018, but about 30% above 2017 levels and about 1.5% of revenue.
The Outlook
I expect orders to slow in this new fiscal year, and I won't be surprised if revenue actually contracts a bit on a reported basis. CMCO's FY'19 revenue and FCF came in almost exactly as I expected ($876 million in revenue and $67 million in FCF versus my estimates of $877 million and $66 million), and I've decided to revise my expectations down to err on the side of caution given the uncertainty and lack of visibility being reported by so many industrial companies.
Although I'm looking for almost no revenue growth over the next three years (a CAGR of 0.3%), I expect long-term growth in the 3% to 4% range. On the margin side, while management has done a great job of exceeding its margin improvement targets, I'm not baking all of the expected improvements into my numbers yet, but I am expecting high-single-digit FCF margins and long-term growth around 6%. In terms of the recently-announced tariff actions against Mexico, I would note that CMCO does have one manufacturing facility in the country (one of 18 facilities, representing less than 3% of manufacturing square footage).
Looking at discounted cash flow and margin/return-driven EV/EBITDA, I believe fair value for CMCO shares is between $43 and $45 today. To be clear, I'm not giving the company many benefits of the doubt here, but the market is being even less generous in terms of its valuation with a forward EBITDA multiple of less than 8x despite what could prove to be double-digit EBITDA growth in the coming years from the margin improvement efforts.
The Bottom Line
Buying into a downturn is a tough way to make money, and I do believe Columbus McKinnon is going to be looking at more challenging end-market demand conditions over the next four to six quarters. I do believe that ongoing restructuring efforts will continue to pay off, and I likewise believe that the company is quietly repositioning itself to leverage emerging opportunities in automation across its addressable market. I certainly can't rule out the risk of another drop below $30 on growing pessimism about the economy, but the risk/reward trade-off here is pretty intriguing for patient investors who can look past this short-cycle pressure.
