Crawford United: Rolling Up Big Profits
Summary
- Upper management has pulled off tremendous feats at the holding company over the last 3 years.
- The flexibility of the business is set up to compound shareholder capital, via acquisitions, at exceedingly high rates of return.
- Positive thesis creep is present due to the change from a sleepy industrial to a compounding machine targeting a large addressable market.
Crawford is a well-positioned industrial roll-up with astute management at the helm. The business has used prudent leverage to increase the quality of its underlying business value since 2017 and continues to do so during current economic weakness. While levered, the durable nature of Crawford's subsidiaries should demand a higher multiple on its shares. In the meantime, investors get to hold onto a growing stream of cash flows at depressed prices.
History
Crawford United (OTCPK:CRAWA) previously Hickok, founded in 1910, began its days focusing on indicators used in both automobiles and aircraft cockpits. The nature of this business relied heavily on a few large OEM customers to initiate new projects. Because of this and its over-reliance on the ebbs and flows of the auto industry, Crawford United began a series of profitable acquisitions geared towards building a quality, yet diverse asset base. On January 8th, 2016 Hickok signed a merger agreement with First Francis Company, where the company would be taken over by the Crawford family entity.
Edward Francis Crawford is a well-respected and highly savvy entrepreneur. He previously served as chairman and CEO of Park-Ohio Holdings (PKOH).
An industrial supply chain logistics and diversified manufacturing business." In 1992, Crawford sold his company Kay Home Products to Park-Ohio Industries. As a result of the transaction, he became not only a major shareholder but also chairman and CEO of Park-Ohio Industries. At the time, Park-Ohio was doing about $60 million in sales. Over time, the company's sales have risen to $1.3 billion. Crawford became president of Park-Ohio in 2018 when his son succeeded him as chairman and CEO. Crawford resigned from Park-Ohio on June 17, 2019.
This induced merger by the Crawford father-son duo created a sea change in the underlying business, developing a growth engine with managerial expertise in acquiring productive industrial assets. Because of their deep supply chain and manufacturing knowledge, and a small capital base, they were advantaged in the space of searching for small, tuck-in acquisitions. These <$25m businesses were highly profitable, yet lacked the institutional and private equity exposure larger enterprises did.
Fresh acquisitions
Starting in 2017 Crawford Industries began its transition period into a nimble growth business. The Industrial Hose segment was added on July 1, 2016, when the Company purchased the assets of Federal Hose Manufacturing. The Commercial Air Handling segment was added on June 1, 2017, after the company purchased Air Enterprises. CAD Enterprise, the Aerospace Components segment was added on July 1, 2018, via acquisition, for $21m.
During FY 19 the company completed two acquisitions. First, the acquisition of Data Genomix, a business that develops marketing and analytic technology. Second, Marine Products International, specializes in rubber and plastic marine hose for the boating industry, for ($9.4m). The MPI acquisition is expected to add nearly $20 million in annual revenue and be immediately accretive to earnings.
Product Durability
While the company's industrial hose segment is a commoditized product, quality & customization of Air Enterprises AC handlers is recognized industry-wide. Some of their larger customers include Massachusetts General Hospital, Mercedes Benz, and the University of Austin. These customers rely on Air Enterprises to deliver crucial energy savings to their units. Between the upfront cost of an AE unit and total energy savings, over a 40 year period, the total savings could be anywhere from $800k-$1m. Coupled with a two to a four-year return of investment, AE's superior cost-benefit is industry-leading. Once a handler is installed customers tend to stay loyal to the incumbent. Therefore, companies with a large installed base, high quality, and lengthy industry tenure tend to continue to prosper.
CAD developed its operations to service and manufacture mission-critical components for the aerospace industry. CAD's flexible engineering and product development techniques allow them to gain and retain valuable customer relationships where it counts. These relationships are sticky because of the long-term contracts that CAD and customers agree upon for multi-year developmental needs. As a provider of mission-critical machined parts, the last thing a customer would want to do is change to a lesser quality competitor.
Strategy
The Crawford family has implemented a succinct, yet effective roll-up plan to grow the revenues and subsequent returns for Crawford United's shareholders. They've maintained a focus on growing out organic revenues in their businesses while continuously looking for prudent acquisitions. They tend to stick with easily understandable industrials with diverse end-users and little correlation to commodity cycles. These additions are typically financed by 40% credit and 60% cash from Crawford. Using an estimated 40% LTV keeps the business conservatively levered while allowing growth in both revenues and net income.
The growth by acquisition strategy has worked wonders for Crawford United's bottom line. Looking in the rearview mirror at their acquisition of Federal Hose ($6.8m), Air Enterprises ($10.2), and CAD Enterprises ($21m), they've effectively bought $11.7m worth of operating profits for $37m of enterprise value. This equates to a yield of 31% and a multiple of 3.2x operating income. After taking into consideration interest paid on these acquisitions of roughly 6.25%, Crawford is creating returns north of 28% per acquisition. While extraordinary, these figures neglect the exceptional organic growth seen recently from CAD and other investments. While heavily tied to the economic cycle, I estimate long-term organic growth at around 4% for their business segments, alone.
Analyzing the recent Marine Parts acquisition for ($9.4m) we see a fairly large difference in price paid vs. previous acquisitions. The MPI acquisition is expected to be immediately accretive to earnings. The purchase brings with it roughly $1.02m of operating income, for a total purchase multiple of roughly 8x operating income. This is 2.5x greater than their average purchase multiple paid in the past. However, as compared to the opportune purchase of Air Enterprises from its distressed parent, Data Cooling Technologies, MPI is in good financial standing and generates 20% returns on its equity.
Source: Crawford United 8-k
The distribution of operating income per segment is broken down as follows:
Commercial Air Handling- 59%
Test and Measurement- <1%, post-2019 will be 0%
Industrial Hose- 5.3%
Aerospace Components- 42%
Corporate & Other- (6.4%)
*MPI Starting FY20'- 30%
Valuation
Source: Authors notes
My estimate of true owners' earnings for FY20' was $2.49 per share. At a share price of $13.30, shareholders would receive an 18% levered yield. The market is for obvious reasons fairly hesitant about the future of an industrial heavy business with exposure to aerospace in this environment. Not to mention Crawford is in the process of integrating the large Marine Products acquisition, with which it saddled itself with nearly $10m in debt. After the acquisition, Crawford will have a debt/equity ratio of 1.05x or 105%. To handicap the current economic impact on Crawford's bottom line, I estimate that even if sales are impacted 50% for the first half of the year Crawford United would receive $2 in owners' earnings. Equating to a 15% yield.
Returns on capital and equity fall 5% until the business is fully integrated, leading to efficient scale and integrated corporate costs. Because of the strategy, management doesn't plan to initiate a share repurchase of common shares or a dividend. In the case of a dividend, shareholders would receive a taxable cash return, resulting in $.85 out of every $1 of capital paid out. Now, the case for a buyback is slightly more subjective. Crawford United has arguably a better business than it ever has; Recurring revenues in its aerospace division, large customers with good financial positioning, and diverse end markets. Historically, they've traded at a 10% yield or 10x earnings. So if a buyback was initiated, every share purchased at the current 6x multiple would generate about 66% more value or $1.66 for every share repurchased.
However, the Crawford family sees the silver lining in the fragmented industrial space, with potentially thousands of sub $25m acquisitions having great economics. Thus far, Crawford United has been able to acquire businesses for 3.2x operating income, on average. After considerations for interest expenses and corporate costs, Crawford is able to generate near 30% returns on acquisitions with a 40% LTV.
At today's purchase price, investors are receiving a risk-adjusted yield of 15% with 4% organic growth coming from expanded product offerings and increased end-market demand. In a normalized environment where economic activity picks back up this yield could increase to nearly 19% or $2.49 from $2. As a free option, there's likely to be a multiple re-rating to nearly 10x earnings when the market realizes the change in Crawford's underlying value thesis. Coupled with continued intelligent acquisitions, Crawford United has the real chance to compound shareholder wealth at a +15% CAGR, assuming the economic headwinds ease in the near term.
Management Alignment
Source: Proxy Statement
The Crawfords and upper management have large financial incentives to see their plan work. I view insider ownership as long-term and directly aligned with A-share equity holders. After the prudent purchase of Hickok and the diligent acquisition work over the last 3 years, there's no reason to believe that the current economic environment won't bear fruit for Crawford United.
Risks
1) Related-party transactions
Convertible Loan Agreement with Roundball LLC: The Company has a Convertible Loan Agreement (the "Roundball Convertible Loan Agreement") with Roundball LLC, affiliated with Matthew V. Crawford and Steven H. Rosen, directors of the Company.
Promissory Notes Issued to First Francis Company Inc.: On July 1, 2016, the Company issued two separate promissory notes to First Francis Company Inc., an entity owned by Edward F. Crawford and Matthew V. Crawford, directors of the Company, in connection with the acquisition of Federal Hose Manufacturing Inc.; one in the original principal amount of $2,000,000, and another in the original principal amount of $2,768,662.
Federal Hose. The Company purchased Federal Hose Manufacturing LLC ("Federal Hose") on July 1, 2016 from First Francis, an entity owned by Edward F. Crawford and Matthew V. Crawford, directors of the Company. The Merger Agreement provided that the Company acquire all of the membership interests of Federal Hose in exchange for an aggregate of (I) 911,250 Class A Common Shares; (II) 303,750 Class B Common Shares; and (III) $4,768,662 in certain promissory notes issued by the Company.
Fluid Routing Systems (FRS). During the fiscal year ended December 31, 2018, the Company purchased an aggregate total of $185,816 of extruded rubber hose and thermal-plastic hose and fittings from Fluid Routing Systems, Inc. ("FRS"), a distributor of hydraulic hose parts and components and wholly-owned subsidiary of Park-Ohio Holdings Corp. ("Park Ohio"). Edward F. Crawford and Matthew V. Crawford are the record and/or beneficial owners of shares of capital stock of Park-Ohio.
Arizona Cast Turbine, LLC. During the fiscal year ended December 31, 2018, the Company, through CAD Enterprises and in connection with the operation of the Aerospace Components segment, purchased an aggregate total of $627,598 of castings from Arizona Cast Turbine, LLC ("ACT"), a closely-held entity in which Edward F. Crawford and Matthew V. Crawford, or certain entities affiliated therewith, own a minority equity interest. CAD's casting supply relationship with ACT pre-dates the Company's acquisition of the Aerospace Components segment.
KT Acquisition LLC (Komtek Forge): During the fiscal year ended December 31, 2018, the Company, through CAD Enterprises and in connection with the operation of the Aerospace Components segment, purchased an aggregate total of $454,210 of forgings from KT Acquisition LLC d/b/a Komtek Forge ("Komtek"), a private entity owned and controlled by Edward F. Crawford and Matthew V. Crawford, or certain entities affiliated therewith. CAD's forging supply relationship with Komtek pre-dates the Company's acquisition of the Aerospace Components segment.
While I don't particularly like seeing related party transactions that line an owner's pockets, there's likely a necessary reason these acquisitions were done through the Crawford Family entities. For starters, access to capital at attractive interest rates isn't relatively easy for a roll-up campaign. Therefore, there may have been a big picture reason to fund these particular initiatives, in-house. There's a risk that these transactions were for the sole benefit of management with secondary emphasis on class A shareholders. If so, management could initiate dilutive activities to fund future growth.
2) The current headwinds will have a negative impact on Crawford's earnings. The air handling segment relies on large commercial real estate owners & developers to invest substantial capital into their air quality & efficiency. These investments are often deferred in such tense environments. Aerospace customers will defer their investments in manufactured parts & components due to the lack of demand for air travel. Boat manufacturing is at a standstill, therefore, limiting the sale of fuel systems to manufacturers from MPI.
3) The unfortunate timing of the MPI acquisition will likely deem expected ROI unrealistic in the short term. The acquisition was made at a higher multiple than previous deals and is yet to be pressure tested. Along with the threat of lower expected returns on this acquisition, Crawford has taken on additional debt to fund purchases. While they stand within their covenant limits of 3.7x debt/EBITDA (2.01x), the fixed charge coverage ratio of 120% (132%), and senior indebtedness/EBITDA of 250% (76%), there's a risk that EBITDA will be compromised near term, leading to a breach of covenants.
4) Most of these underlying businesses, while diverse, have very concentrated customer bases. Three customers made up 12% of sales for Air Enterprises during FY19. One customer in the aerospace division accounted for 29% of sales in that same year. Overall, Crawford United's top ten customers provide 53% of consolidated revenues. In times of economic slowdown, these core customers will cut their budgets, therefore, leading to a larger impact than previously foreseen on Crawford United's bottom line.
Value Proposition
There are a few reasons that the mispricing in Crawford's underlying stock exists. 1) The market sell-off has indiscriminately punished companies with leverage. 2) Crawford United has a sub $50m market cap with even less liquidity in its public float. 3) The thesis has vastly changed since its humble beginnings as a seller of industrial test & measurement products in 2016. 3) The recent acquisition of MPI has yet to fully prove itself as a valuable add-on.
The runway for Crawford's industrial-acquisition expertise, using low multiples paid on assets coupled with strong market-leading brands will create shareholder returns in excess of 15%. With an increased capacity on their revolving credit facility, this team of aligned owner-operators will use current weakness to snatch up assets at fire-sale prices.
Analyst’s Disclosure: I am/we are long CRAWA. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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