Seeking Alpha: A Strong Order Book Can Drive MTS Systems, But Watch The Margins

Over the last six months or so, MTS Systems (NASDAQ:MTSC) has remained a consistent (and perhaps frustratingly consistent) story. The stock has done a little better than the S&P 500 since my last piece, and the company has been logging good order growth, but order growth has been slowing and the company's margin trajectory hasn't been strong.

It's hard for me to work up a lot of enthusiasm for the shares at today's valuation. A large backlog of custom orders will make margin leverage more challenging, and I have my doubts as to whether today's global economic environment is conducive to a re-acceleration of orders. I presently think that the mid-$70s is about where the shares ought to trade, but I will note that if management can hit its revenue growth and margin leverage targets (both of which are above my estimates), a fair value in the high $80s to low $90s comes into play.

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A Strong Order Book Can Drive MTS Systems, But Watch The Margins

Seeking Alpha: Order Growth Starting To Support The MTS Systems Story

MTS Systems (NASDAQ:MTSC) is not at all a well-known company - just two analysts follow this manufacturer of industrial testing systems and sensors - but what it lacks in popularity may not matter to patient investors. The company is well-placed to take advantage of growth in the Chinese auto OEM sector, as well the ongoing trend across multiple industries to make greater use of composite materials, and is supplementing its traditional strength in testing systems with a growing higher-margin sensor business and an increased focus on service.

These shares have more or less tracked the S&P 500 since my initial write-up in September, but better things could be in store relatively soon. Order levels have accelerated recently and the company should be nearing the end of margin pressures tied to upfront spending meant to grow the service business. Although I still do not believe the company will hit management's ambitious revenue growth targets over the next few years, the shares do appear undervalued and hitting those targets could be an invaluable source of upside.

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Order Growth Starting To Support The MTS Systems Story

Seeking Alpha: MTS Systems Waiting For A Better Cycle

Industrial test system and sensor manufacturer MTS Systems (MTSC) is the sort of small company (if over a half-billion dollars in sales is truly small) that just does what it does, year in and year out. As the company's customers operate in cyclical markets, MTS Systems' business inherits some of that cyclicality, but the company reliably delivers very good returns on capital as a byproduct of its strong market share and long customer relationships. With the shares not quite recovered from a post-earnings swoon, there is some value here though it is not a severely undervalued stock at this point.

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MTS Systems Waiting For A Better Cycle

Seeking Alpha: MTS Systems Isn't Afraid Of Bold Expectations

For many companies, the role of CEO comes down to carefully massaging expectations such that institutional shareholders stay happy and stock options end up in the money. That sort of attitude doesn't lead to much in the way of boldness, and it probably goes some length to explain just why "average" performance is often so mediocre.

MTS Systems (MTSC) isn't like that, though. Management here has laid out bold targets - compound revenue growth of over 10% through 2018 and doubling revenue to $1 billion. Double revenue in six years would be aggressive for most companies, let alone a company that serves cyclical industries like autos and aerospace and competes with large companies like Illinois Tool Works (ITW) and Moog (MOG.A). While I'm not 100% convinced that management will hit that market (it's a goal, not a guarantee), I do believe that even a "near miss" would make these shares undervalued at today's price.

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MTS Systems Isn't Afraid Of Bold Expectations