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Why Timken Post-Spin Is Not A Bargain

|Includes: NNBR, ROLL, STLD, Timken Co. (TKR)

On June 19 Timken management presented its outlook to institutional investors. Per our "less is more" approach we cull everything to the key points and point those interested in detail to the company's very well done slide deck. Our observations and thoughts follow.

Guidance - expect 2014 earnings of $2.40-2.60 adjusted ($2.45-2.65 GAAP) on post-spin revenue of $3.0-3.2 billion, about $1B below peak owing to auto related divestitures. Free cash flow of $250 million. Margin around 12% (5 year average) and below 14.3% peak. Goal is to achieve 14% margin through cycle instead of "peak."

Mobile (48% of sales) - sales guide raised to (3-5%) from (3.8%) - up 2-4% ex divestitures - with margin of 10-13% and long-range target of 13% plus.

Process (41% of sales) - expect sales +10-12% in '14. Asia (21% of segment revenue) is the key long-term growth driver.

Aerospace (11% of sales) - lowered sales guide to 0-3% in '14 from +5-10% citing order push-outs and "complex issues." Margin remains depressed at 7-9% in '14 - flattish yy - and below 13%+ long-term target. Focus on fixing supply chain issues and getting $5M of costs out (~160 bps) next 12-18 months.

Capital allocation - 1.5 million remaining share repurchase authorization, incremental 10 million just approved will boost debt/capital to 30-40% target range from 12%, and debt/EBITDA to 2.0-2.5X. Will seek bolt on deals of $200 million or less with emphasis on reducing cyclicality. Deal focus on niche bearing companies particularly for Process. Customer uptime is valued, switching between bearing suppliers is rare.

Valuation - our 4/14/14 Spin-Off Analysis of Timken Steel put a value of $1.9-2.2 billion on the business - right now it trades at a $1.7 billion market cap when issued and backs into about $49 for TKR post spin ($68 - $19 = $49). Midpoint of FCF per share range of $2.74-3.12 (pre/post share repurchase) is close to $3/share. TKR trades in line on a PE basis with STLD, NNBR, ROLL, etc. - which is to say expensive. Using FCF yields of 7%, 6% and 5% could derive target prices of $43, $51, or we suppose $60.

The stock - fairly valued.

MIX DETAILS

     

END MARKETS

   

Automotive

Mobile

15%

Heavy Truck

Mobile

10%

Rail

Mobile

9%

Agriculture

Mobile

7%

Construction

Mobile

4%

Other

Mobile

3%

     

Industrial Machinery

Process

19%

Metals

Process

6%

Mining

Process

5%

Industrial Services

Process

5%

Energy

Process

4%

     

Defense

Aerospace

7%

Aerospace

Aerospace

6%

     
     

GEOGRAPHY

   

North America

 

59%

EMEA

 

18%

APAC

 

15%

Latin America

 

8%

     
     

CHANNEL

   

Aftermarket

 

47%

Original Equipment

 

37%

OE Service

 

16%

     
     

PRODUCT

   

Tapered Roller Bearings

 

60%

Power Transmission

 

9%

Services

 

9%

Other Bearings

 

22%

     
     
     

Market position - $3 billion in sales within a $55 billion global market. Timken holds about an 18% share in Tapered Roller Bearings, and is launching new products extending beyond that piece of their revenue base (currently 60% of total).

Management sees potential to redefine total addressable market to $500 billion Mechanical power transmission products and services. Specific areas could include:

•Gear and drive services

•Aerospace transmissions

•Chain

•Lubrication systems

•Other

Management sees 4-5% organic revenue growth long-term and another 3-5% per annum from deals. Deal activity since 2010 (year, # of deals, total revenue acquired):

2010 - 1 deal, $14 million

2011 - 2 deals, $185 million

2012 - 1 deal, $30 million

2013 - 3 deals, $61 million

2014 - 1 deal year to date, $18 million

L&C View - that industry growth rate sounds aggressive and we sense TKR is giving itself a path to become a "focused general industrial" within a defined space. Conversely, as a contributing columnist for Power Transmission Engineer magazine we pay attention to the gear space and Timken's acquisition of Philadelphia Gear a few years back was obviously well enough digested to encourage more deals. Key end markets include wind, auto, aerospace and mining.

Scale potential? - Timken generates revenue out of 61 global manufacturing facilities in 28 countries or about $50-55 million in revenue per plant.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.