SPX FLOW Highlights Some Ongoing Turbulence In Flow/Process Control

 

This has been an interesting quarter for companies in the flow control space. While many end-markets are quite strong, including food/beverage, biopharma, and pulp/paper, and others are starting to improve (chemicals, among others), many companies are reporting weak-looking results as improving short-cycle demand is counterbalanced by a slower pickup in larger project-oriented spending.

Such is the case with SPX FLOW (FLOW), and in this specific case there are also "order selectively" decisions pressuring reported results, as management continues with a plan to boost future margins and growth sustainability by getting more selective with the large project-type orders it takes on. Nevertheless, SPX Flow earnings do support underlying strength in the flow control space - good news for companies like Alfa Laval (OTCPK:ALFVY), Dover (DOV), Emerson (EMR), and IDEX (IEX).

SPX FLOW is in the process of being acquired by private equity group Lone Star Funds for $86.50/share. I do not expect any counterbids, and I would expect the deal to close in the first half of 2022. With less than 1% upside to the deal price, I see no reason for investors to hold SPX FLOW shares any longer.

 

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SPX FLOW Highlights Some Ongoing Turbulence In Flow/Process Control

SPX FLOW's Go-It-Alone Strategy Is A Reasonable Bet On Its Turnaround Plan

 

I thought that SPX FLOW (FLOW) offered a good return relative to its price back in late May, and apparently, Ingersoll Rand (IR) felt the same, as this would-be empire-builder in flow control made two bids for SPX FLOW this summer, including an $85/share all-cash bid, before walking away after SPX FLOW rejected its overtures.

Management has since initiated a “strategic review” but given the new strategic plan unveiled at the March Investor Day, consideration of a sale is really the only new option that could be on the table, and I think it will be tough to top an $85/share deal in the short term.

I do see meaningful self-improvement potential at SPX FLOW, and I’m always the guy going on about how “successful turnarounds can surprise and exceed investor expectations”. Turning down a no-risk $85/cash offer will no doubt lead to a little extra scrutiny on management’s execution of its turnaround/value creation plan, but I think they’re up to the task and patient investors may well be better off if they stay independent a while longer.

 

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SPX FLOW's Go-It-Alone Strategy Is A Reasonable Bet On Its Turnaround Plan

SPX Flow Continues To Build A More Positive Case For Itself

 

As a long-term investor, I try not to spend too much time fretting over short-term price movements, but I do think the recent performance of SPX FLOW (FLOW) highlights the impact valuation and expectation can have on performance. SPX FLOW shares are up modestly (around 7%) since my last update, lagging the mid-teens performance of the larger industrial group, despite what I thought was a strong Investor Day presentation and a very good set of first quarter results.

I like management’s “80/20” strategic plan and the decision to focus more attention on growth opportunities in the Nutrition & Health and Industrial segments, as well as the decision to deploy more capital into M&A. I think management’s target of mid-teens adjusted operating margins in 2023 could be a little aggressive, but I do think the company is on a better path now as it transitions from a turnaround story to a quality (if cyclical) growth story.

Between the Investor Day presentation, the first quarter results, and trends I see across the company’s end-markets, I’m more comfortable with more bullish assumptions, and I think M&A could push the longer-term revenue growth rate closer to the high end of the mid-single-digits. Assuming that FCF margins move into the low double-digits (and there could be upside here if management really delivers on efficiency efforts), I think there’s a potential high single-digit long-term annualized return here, and that’s pretty attractive on a relative basis.

 

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SPX Flow Continues To Build A More Positive Case For Itself

SPX Flow Executing On Cost Efficiency And Has Meaningful M&A Upside

I was concerned about the fairly rapid improvement in valuation when I last wrote about SPX Flow (FLOW) and noted that further upside was going to be more tied to real evidence of operating improvement. To that end, while SPX Flow didn’t have a perfect second half of 2020, management made very credible progress on cost efficiency targets, and that helped SPX Flow almost double the performance of the broader industrial space, sending the shares almost 50% higher.

SPX Flow enters 2021 with good leverage to improving short-cycle industrial markets and more stable (but growing) food/beverage customers. Management is targeting another round of cost cuts (which could impact operating margins by 150bp) and enters the year with meaningful M&A capacity. Valuation does look pretty robust, but with relatively better operating margin improvement potential and M&A upside, I’m not really expecting to see SPX Flow trade cheaply in the near term.

 

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SPX Flow Executing On Cost Efficiency And Has Meaningful M&A Upside

SPX Flow: Undemanding Valuation, But Uninspiring Drivers

It’s not enough for a company’s shares to be cheap. By and large, unless there’s something within the story that can drive better performance (or at least better than expected performance), a cheap stock without drivers can stay cheap for a frustratingly long time, leading to the so-called “value trap” that is the bane of value and GARP investors.

And that’s basically my issue with SPX Flow (FLOW) in a nutshell. The shares do look undervalued, but it’s hard to find much about this business that’s really exciting. The Food & Beverage business is good and somewhat defensive, but the Industrial business is a more typical short-cycle equipment business and the overall margins don’t impress. An under-leveraged balance sheet gives management some options, but it’s tough to get excited about the operating story here.

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SPX Flow: Undemanding Valuation, But Uninspiring Drivers

Better Clarity On Future Growth Drivers Could Help SPX Flow Take The Next Step

By and large, it's better to invest in the best businesses you can find, but there's a fair price for every going concern, and you can make money with lesser companies if you buy them right. With that in mind, I'd note that SPX FLOW (NYSE:FLOW) shares have outperformed the industrial sector by a decent margin since I recommended them as a "it's not a great company, but it's better than this" pick back in May.

What happens next will have a lot to do with the company's growth investment plans, including how the company chooses to uses the proceeds from its sale of the Power and Energy business. There are solid arguments for reinvesting in and further building businesses like industrial mixers, dehydration equipment, and tools, but management should at least consider expanding into more specialized pump/valve end-markets like biopharma.

With SPX's decent market performance, the shares no longer look as appealing to me. I like the prospect for better growth and margins after the P&E sale, not to mention the flexibility and options the sale may give management, but the valuation is just "okay" now, and I see some near-term risks in both the Food & Beverage and Industrial segments for a few quarters.

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Better Clarity On Future Growth Drivers Could Help SPX Flow Take The Next Step

Low Expectations And Portfolio Transformation At SPX Flow

When I last wrote about SPX Flow (FLOW), I wasn’t too enamored with the stock, as the company’s orders seemed underwhelming relative to the cycle and I didn’t like the near-term prospects for growth and margin improvement. Since then, the shares are down about 10% (including a strong post-earnings move), lagging the broader industrial sector by close to 20%, not to mention peers/rivals like Alfa Laval (OTCPK:ALFVY) and Flowserve (FLS) – in fact, until this post-earnings spike, the shares had been lagging troubled GEA Group (OTCPK:GEAGY), and that’s really not a good thing.

I don’t believe SPX Flow is a vastly better business today than a year ago, but I have seen progress on margin and portfolio improvement efforts, the most obvious example being the decision to look to divest the lower-margin Power & Energy business, but also including subtler moves like deprioritizing larger dairy orders. What’s more, the expectations embedded in the business seem quite low. I do have some concerns that this could be a value-trap, but the value proposition is interesting.

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Low Expectations And Portfolio Transformation At SPX Flow

A Better Quarter From Colfax, But Plenty Of Work Still To Do

Healthier demand in manufacturing and heavy industry is positive tide that is lifting a lot of boats these days, and Colfax (CFX) too is seeing some benefit. While the company continues to go through a painful adjustment process in its Air & Gas Handling business, the trend should start to improve relatively soon and there seems to be room for more growth in multiple end-markets. Management also seems to be more inclined to restructure and buy back shares rather than add a new business group, and that looks like a smart decision on balance for the time being.

I’ve been clear in the past that I have serious doubts about this business; I am not sold on the long-term value of the Air & Gas Handling business and I think the company will struggle to make real headway in welding. That said, low expectations, a relatively high short ratio, and improving end-market trends, coupled with what looks like responsible decisions on the part of management, does support value here even after a decent run over the past couple of months.

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A Better Quarter From Colfax, But Plenty Of Work Still To Do

Alfa Laval Flexing Its Late-Cycle Muscles

I liked Sweden’s Alfa Laval (OTCPK:ALFVY) (ALFA.ST) earlier this year as a late-cycle play on stronger Marine and Energy orders, as well as decent prospects for ongoing growth in the Food/Water business. Much of that has come to pass, and the shares are now about 20% higher than they were at the time of that last article. Alfa Laval has since logged two very strong quarters, and those hoped-for improvements in the company’s three main business lines have materialized with stronger revenue, orders, and margins.

With the strong move in Alfa Laval’s share price, not to mention some growing concerns about how much is left in this current industrial upswing, I believe these shares have moved from good idea to okay idea. The implied long-term return is still in the high-single digits, which isn’t bad, and I won’t be too surprised if the company has at least one more better-than-expected quarter up its sleeve. Still, I wouldn’t push my luck too far, even though I regard this as a well-managed operator in some attractive businesses.

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Alfa Laval Flexing Its Late-Cycle Muscles

SPX FLOW More Focused, But Iffy Order Flow Is A Concern

Investors are trying to figure out where industrials are headed, and SPX FLOW's (FLOW) share performance so far this year reflects a lot of that uncertainty. The market liked what management had to say at its early March investor meeting (after which the shares traded into the mid-$50's), but disappointing results and guidance across the sector had investors worried going into earnings, taking the share down into the low $40's, before the results brought some stability to the shares.

It's an interesting coincidence (and perhaps not just coincidence) that SPX FLOW's share price performance puts it almost directly in the middle of Alfa Laval (OTCPK:ALFVY), better-run and with better near-term prospects, and the rolling train wreck that is GEA Group (OTCPK:GEAGY). Although the shares seem to have a little bit of upside here, I'm concerned that the Food & Beverage business could stay weaker for longer and that management may not be able to maximize the opportunities in the power and energy rebound.

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SPX FLOW More Focused, But Iffy Order Flow Is A Concern

Change Is Coming At GEA Group, But It May Take Time To Arrive

When I last wrote about GEA Group (OTCPK:GEAGY), I said there were still meaningful risks that the company could disappoint investors even further… and that's exactly what they have done. With yet another weak quarter in the books, and no credible prospects for a near-term reversal in what is now a long trend of disappointment, this is a tough stock to own today.

There are some pieces of good news, though. First, the management that steered GEA Group into this mess is on their way out. Second, the underlying assets and operations still have value and, I believe, can generate attractive returns with the right plan/management in place. Although the shares still look undervalued after once again lowering expectations and could have significant long-term turnaround potential, investors buying/holding today should probably accept that it's going to be a year or longer before there's real change at GEA Group.

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Change Is Coming At GEA Group, But It May Take Time To Arrive

Outside Of Energy, SPX Flow Still Waiting For The Turn

At a time when many industrial companies are seeing strong cyclical recoveries, SPX FLOW (FLOW) is still well off the pace of many of its industrial peers. Although markets like energy, air treatment, and chemical processing still have scope to improve from here, the company's food and beverage segment is likely to be a slower grower and SPX FLOW is going to have to start making more progress on share-of-wallet and internal margin improvement efforts.

Up more than a third from when I last wrote about the stock, I'm not as bullish on SPX FLOW now as I think the catch-up opportunity has largely materialized. There are multiple places where management could execute better over time, but I think those opportunities have to be considered in hand with the likely slower growth that SPX FLOW will see compared to many other industrials. I don't dislike the shares, but I don't see the opportunity I once did.

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Outside Of Energy, SPX Flow Still Waiting For The Turn

Alfa-Laval Still Offers Recovery-Driven Upside And The Potential For Improved Execution

For the most part, well-run multi-industrials exposed to recovering markets are not trading at very attractive prices today, and that makes Sweden’s Alfa-Laval (OTCPK:ALFVY) worth a look. It’s certainly too soon to sound an “all clear” on the company’s large marine business, but order growth has been steadily improving and margin leverage is starting to emerge again. With leadership in multiple recovering markets and the potential to significantly improve returns on capital from here, Alfa-Laval is worth a look.

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Alfa-Laval Still Offers Recovery-Driven Upside And The Potential For Improved Execution

SPX Flow May Still Be Ugly Enough To Love

Life has not been easy for SPX Flow (NASDAQ:FLOW). Based upon what happened to other companies with significant oil/gas exposure like Dover (NYSE:DOV) and Emerson (NYSE:EMR), as well as power generation (also relevant to Emerson), it is no great surprise that a company leveraged to selling pumps and valves to upstream and midstream energy companies would be weak. But then dairy processing weakened significantly and kicked out another leg of SPX Flow's stool. With that, annualized revenue from the last quarter was about 30% below the level of 2012 and the company's efforts to improve its cost structure have largely been buried by operational deleverage.

Not all of SPX Flow's problems have been macro-driven (there have been some self-inflicted wounds along the way), but I do believe that there is a reasonable price for most going concerns and I think SPX Flow may be below that level. Orders have started to improve and I believe margins have bottomed out. Although I'm not looking for a V-shaped recovery in oil/gas, and I believe food/beverage isn't going to grow like it used to, modest revenue growth and margin improvements can drive a fair value close to $40. As a stock that hasn't really rocketed up on its recovery prospects, I think SPX Flow might be worth a closer look.

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SPX Flow May Still Be Ugly Enough To Love

Management Unreliability Has Soured The GEA Group Story, But Value Remains

Eighteen months or so ago, I thought GEA Group (OTCPK:GEAGY) (G1AG.DE) looked fully valued despite the long-term attractiveness of a leading company in the food/beverage automation and equipment market. Since then, confidence in management has soured due to an extended period of underperformance and questionable moves like a substantial guidance reduction only a couple of weeks after the 2016 Capital Markets Day. 

GEA Group's dairy processing end-market, which is responsible for around 20% of sales, is likely to struggle for another year or so, but farming, food/beverage, brewing, pharmaceuticals, and industrial markets (including oil/gas) are looking better. What's more, an activist investor is now involved in the shares, which may put a little more pressure on management to up its game. 

I do have some worries about recent cost overruns on new projects and self-inflicted inefficiencies, but I believe the food and beverage markets are attractive long term and I believe GEA Group can get back to double-digit returns on capital. Even with lower assumptions regarding revenue and margins (versus my last article) and a higher discount rate, these shares now look a little undervalued and worth a look from patient investors. 

Investors should note that GEA Group's ADRs don't offer optimal liquidity, so those investors willing and able to trade on foreign exchanges may want to consider buying GEA Group shares on its home exchange.

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Management Unreliability Has Soured The GEA Group Story, But Value Remains