Ingersoll Rand Checking All Of The Street's Preferred Thematic Boxes
- Ingersoll Rand has been on a tear in an already-hot industrial sector, with many thematic elements working in the stock's favor.
- Guidance for 2021 may be conservative, and IR is well-positioned for a short-cycle industrial recovery, as well as further cost synergy upside.
- M&A should be a source of value; management made a good deal for the HPS business and will likely pursue additional low-risk tuck-in deals.
- Valuation remains the obstacle. I love a good story, and IR checks a lot of thematic boxes, but I can't make the numbers work relative to valuation.
Investors love a good story, and Ingersoll Rand (NYSE:IR) is certainly obliging them, as this company checks almost all of the Street's preferred thematic boxes right now. Ingersoll Rand is strongly leveraged to the short-cycle industrial recovery, passed through the downturn with excellent decremental margins, offers outsized synergy opportunities, has M&A optionality, and offers a market share growth/leverage story, as pre-break up Ingersoll Rand didn't invest as much into its industrial businesses. Frankly, all that the story lacks is leverage to industrial software, HVAC/green retrofit, or life sciences/bioproduction, and even on the latter point, there is leverage to medical/scientific fluidics.
I thought Ingersoll Rand already had a pretty healthy valuation in August, but I grossly underestimated how much more the Street would pay for the company's leverage to the post-pandemic recovery and that thematic excellence. With that, the shares are up about 40% since my last article, roughly doubling the return of the larger industrial group and handily outperforming Atlas Copco (OTCPK:ATLKY) as well.
I still have issues with valuation, as mid-to-high single-digit revenue and FCF growth and over two points of operating margin improvement from 2021 to 2023 can't really get me to a good place on valuation. I don't discount the upside potential from more M&A moves, nor the opportunities to gain share or the value of a good story, but the drivers for further outperformance seem more limited to me.
A Healthy Beat, With Likely Conservative Guidance
Ingersoll Rand did itself no harm with a good fourth quarter report.
Revenue fell more than 7% in organic terms (to $1.51B), worse than the industrial group average of a roughly 4% organic contraction, and the exclusion of the High Pressure Solutions business wouldn't alter that much. Still, that was good for a 3% beat relative to expectations.
Gross margin declined about two points to 34.9%, while EBITDA rose 10% to $344M (margin up three points to 22.8%), beating by more than 11%. Strong EBITDA performance was driven in part by ongoing cost synergies from the IR-Gardner Denver combination.
Industrial Technologies and Services (or ITS) saw 8% revenue contraction to $1B, good for a small beat (a little less than 2%), but the low single-digit decline in compression was well below the 7% growth reported by Atlas this quarter. Vacuum and blowers revenue also declined at a low single-digit, while tools and lifting declined at a high teens rate (the latter consistent with Columbus McKinnon (CMCO)). Segment EBITDA jumped 12% (margin up four points to 26.1%), and this outperformance drove most of the full-company EBITDA beat.
Precision and Science Tech (or PST) also saw a nearly 8% revenue decline (to $207M), missing by 2%, with medical sales up 4% and Dosatron up 14%. Relative to other process industries, like Graco's (GGG) Process segment, this was an in-line performance. EBITDA improved 7% (margin up about three points to 30.8%).
Specialty Vehicle Technologies rose more than 8% to $246M, beating by more than 7%, with EBITDA up 40% and margin up better than four points to 18.7%. High Pressure Solutions saw a 41% revenue plunge to $46M (still good for a 23% beat), with EBITDA down 84% and margin down almost 15 points to 5.4% on weak demand in the oil/gas sector for frac pumps, mud pumps, and similar equipment.
Guidance May Prove Conservative
While Ingersoll Rand management's guidance was positive (EBITDA midpoint about 1% higher than the prior sell-side average), it may also prove conservative. Guidance for mid-single-digit growth, including the ITS business, is largely in line with the low-to-mid single-digit growth targets of most industrial companies, but there have been some short-cycle names (Illinois Tool Works (ITW) and Rockwell (ROK), for instance), willing to put out more ambitious targets for their short-cycle industrial markets.
Organic orders in ITS rose 1%, with mid-single-digit growth in compression (versus 5% for Atlas) and double-digit growth for blowers. IR also saw very strong orders in the medical business of PST and the SVT business, as consumer demand (including golf) has remained quite strong.
All in all, IR serves markets about which I feel pretty confident today. A lot of the company's compressor, blower, and pump sales go into "general industrial" markets, making it tougher to tease out trends, but overall economic activity (as measured by PMI and other metrics) continues to look encouraging for 2021.
Ongoing Self-Help Opportunities
Ingersoll Rand produced excellent decremental margins in the downturn (15%, or 2% excluding HPS), and while the synergy benefits of the Gardner Denver-IR combination no doubt played a major role, the fact remains that IR out-executed on costs/margins. Moreover, management boosted their synergy target by $50M to $300M.
It's not just costs where the company is doing well. Management called out strong execution on converting sales leads and customer inquires into orders, and I think Ingersoll Rand is on better footing than ever before in businesses like compression, where it is at least plausible that clawing back some share from Atlas is in the cards. The company is also prioritizing investments in areas like greener technology (more energy-efficient products), as well as IoT, with a partnership with Google (Google Cloud Platform).
Management is also remodeling the business. Shortly before the fourth quarter earnings, the company sold a 55% stake in HPS to a private equity buyer. Yes, IR is not getting full value for this cyclically-depressed business, but in selling a 55% stake, there's still upside participation if/when the market for fracking pumps and other oil/gas hardware recovers.
On the flip side, the acquisition of Tuthill Vacuum and Blower is a logical tuck-in deal, and I expect further strategic tuck-in deals in the years to come; deals that fill product portfolio holes, bring in interesting technologies/features, and/or improve and leverage the sales infrastructure.
Even giving credit to Ingersoll Rand for better sales execution, a stronger end-market recovery, and more cost synergies, I can't really make the numbers work from a valuation perspective. I expect mid-to-high single-digit long-term growth (mid-single-digit for revenue, mid-to-high for FCF), with significant FCF leverage and over two points of operating margin improvement from 2021 to 2023, and it doesn't really get me anywhere on valuation. In fact, even with the improvements I expect, Ingersoll Rand will still be pretty lackluster as far as metrics like operating margin and ROIC are concerned.
The Bottom Line
I fully realize that, at least in the short term, story and sentiment matter more than numbers. I also don't intend this as a backhanded compliment toward the company; I like this company quite a bit and I think this is a classic "2+2=5+" situation. My issue remains valuation. I realize that valuation is not a short-term impediment to further share price performance, but I have to stick to the principles that have worked for me for many years, and Ingersoll Rand just doesn't work for me today from a GARP perspective.
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