Regal Beloit Still Underappreciated On Its Recovery, Expansion, And M&A Leverage

 

Shorter-cycle industrial stocks haven’t been doing as well lately, with the market worried that growth is already peaking and preferring instead to move on to longer-cycle ideas or theme stocks (automation, electrification, HVAC, et al). That hasn’t helped Regal Beloit (RBC), as the shares had been lagging the broader industrial space since my last update until a recent post-earnings run.

I continue to believe that Regal Beloit is underappreciated for its leverage to automation and HVAC, as well as a longer recovery/expansion cycle across the industrial markets it serves. Add in synergy benefits from the coming acquisition of Rexnord’s (RXN) Process & Motional Control (or PMC) business, and I think there’s more to this story than is being reflected in the share price.

 

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Regal Beloit Still Underappreciated On Its Recovery, Expansion, And M&A Leverage

Regal Beloit Offering Cyclical Leverage And Deal Synergy

With short-cycle industrial markets firmly in recovery mode and longer-term opportunities in HVAC and industrial automation, end-market conditions are looking pretty supportive these days for Regal Beloit (RBC). Strong execution in tougher markets in 2019 and 2020 likewise lends more credibility to management’s cost reduction targets, as the company definitely outperformed expectations for decremental margins during the pandemic downturn.

On top of that, the acquisition/merger with Rexnord’s (RXN) Process and Motion Control business (or PMC) creates new synergy opportunities on both the cost and revenue lines, with the deal also significantly enhancing Regal Beloit’s Power Transmission business.

I can see near-term upside in Regal Beloit to around $160, and above-average longer-term total annualized return potential beyond that. It is a cyclical, largely short-cycle, industrial business, but one where I believe there are both revenue and margin tailwinds to drive the business.

 

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Regal Beloit Offering Cyclical Leverage And Deal Synergy

New Tariffs Create New Headaches For Rockwell Automation

At the time of Rockwell’s (ROK) fiscal second quarter earnings report in late April, I commented that I thought investors would have an opportunity to buy shares in this high-quality automation enabler at a lower price. Since then, the shares have dropped more than 15%, significantly underperforming industrials in general, on growing concerns about a slowdown in the industrial end-markets that make up a large part of the discrete automation market. Now with the prospect of significant tariffs on Mexico on the table, Rockwell is taking another body-blow.

I do believe that Rockwell management is underestimating the risk of a broader slowdown in industrial end-markets, even though I do basically agree with its more bullish medium-to-long-term outlook. With a real risk of a “lower-for-longer” end-market demand situation and now potential pressures from new tariffs, I’m inclined to keep waiting even though Rockwell shares now trade below my estimate of fair value.

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New Tariffs Create New Headaches For Rockwell Automation

Rexnord Starting Its Cyclical Upswing

Improving end-markets across numerous industrial, consumer, and construction markets have largely mopped up most of the quality undervalued industrials stocks, and Rexnord (RXN) is no exception. The shares are up about 20% since my last update on the company, beating peers in its Process & Motion Control business like Regal Beloit (RBC) and Renold (OTC:RNOPF) and more or less matching its prime rival in Water (Watts (WTS)). Although the shares no longer appear fundamentally undervalued, the relative valuation is a little more appealing, and Rexnord's markets continue to improve, which could offer a little more appeal for less value-sensitive investors.

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Rexnord Starting Its Cyclical Upswing

Rexnord Should Be Seeing A Turn Now

I liked Rexnord (NYSE:RXN) back in mid-December, and I can't really complain with how the shares have performed since. Not only is the return about 10 points above that of the S&P 500, but Rexnord has done alright next to most of its process/motion control peers like ABB (NYSE:ABB), Altra (NASDAQ:AIMC), Regal Beloit (NYSE:RBC), and SKF (OTCPK:SKFRY), as well as peers in the water products sector. Better still, short-cycle industrial activity is picking up (including in the industrial MRO space) and process industries like mining seem to be past the worst, while core food/beverage continues to perform well. Add in a slowly improving institutional water market and some longer-term strategic growth opportunities and it's a relatively solid backdrop.

Valuation is no longer so compelling, but "meh" seems to be the new "bargain-priced" in the industry sector and shaving just half a point off of my 10% discount rate would give me a fair value slightly above today's price. Provided that Rexnord can show some healthy signs in its core revenue and margins later this week when it reports fiscal fourth quarter earnings, not to mention constructive guidance in line with what other industrial-leveraged companies have said, this could still be a name with some room left to advance.

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Rexnord Should Be Seeing A Turn Now

Rexnord Still A Work In Process

It has been a while since I've written on Rexnord (NYSE:RXN), largely because I thought the valuation wasn't all that interesting back in mid-2013. The shares are up about 10% since then, which is well below the return of the S&P 500, but in line with rival Regal Beloit (NYSE:RBC) and better than ABB (NYSE:ABB). Since the time of that last article, Rexnord has borne the brunt of a rough stretch in its industrial and resource-centric end-markets, and the company's margins have gotten worse, bringing the company down to mid-pack (or a little worse) in the industrial conglomerate space.

These shares have had a run since the election, but there may still be enough value here to merit a closer look. I really like the company's leverage to healthier end-markets like aerospace and food/beverage, as well as the prospects for improvement in industrial markets, eventual improvement in resource industries, and possibly a renewed focus on water infrastructure spending in North America. I believe management still has to earn the benefit of the doubt with respect to margin improvements, but mid single-digit FCF growth can support a fair value above $21 and a double-digit total expected return.

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Rexnord Still A Work In Process

Seeking Alpha: Emerson Skidding On The Oil Spill

There's not a lot more left to say about the state of multi-market industrial conglomerates that I haven't already said. Companies that have outsized exposure to commodity/resource markets and emerging markets, and that definitely includes Emerson (NYSE:EMR), are getting hit hard and there isn't much relief in sight. Although Emerson's CEO believes that orders will bottom in the spring of this year, that's well outside of the norm of what most peer company CEOs are saying and the company's lack of exposure to relatively healthier markets like aerospace, auto, food/bev is a drawback.

Emerson has been going through tough times longer than its peer group and management seems more realistic about the need for capacity curtailments. Even so, I think the company could find it hard to get full value for its Network Power business and the Industrial Automation assets it has targeted for sale. Emerson scores well for its margins and returns on capital, but it's hard for me to see how the company generates enough revenue growth to really drive an attractive fair value from here.

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Emerson Skidding On The Oil Spill

Seeking Alpha: Can Altra Holdings Become A Clutch Performer?

Not only do I like industrial companies in general, but small industrial companies are near and dear to my heart. Played right, they can be surprisingly lucrative stock picks with much less of the risk that often goes with small technology or healthcare names.

The question for this article, then, is whether Altra Holdings (AIMC) merits a spot in the portfolio of growth-inclined investors.

An Annoying Reset To End The Year
The Altra Holdings case doesn't start off especially strong, as though revenue rose 11% organically in the fourth quarter, the company missed earnings estimates by a significant margin.

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Can Altra Holdings Become A Clutch Performer?

Investopedia: A Better 2012 Would Be Great For Actuant

Wall Street has already made its early bets on the state of the economy in 2012, and the outlook is not very encouraging. That would be bad news for investors in a diversified industrial mini-conglomerate like Actuant (NYSE:ATU) if not for the fact that Wall Street is often wrong. Although Actuant has recovered nicely from the worst of the recession and does have increasingly challenging comparables ahead, any upside in 2012's economic performance could make this an undervalued industrial play.

A Good Start to the Fiscal Year
Perhaps this quarter will set the tone for a better-than-expected fiscal year and an undervalued stock getting some love. Actuant reported 23% revenue growth and topped the highest analyst estimate, though core revenue growth was a far more modest 7%. Growth was strong in both the industrial and energy categories, where revenue rose by a low-teens percentage organically. Electrical growth was more modest at 7%, while core growth in the engineered segment was flat.


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A.O. Smith Gets Out While The Getting Is Good

It looks like ABB (NYSE: ABB) has managed to shake up the electrical motors business. In the press release announcing a deal whereby A.O. Smith (NYSE: AOS) will sell its motors business to Regal-Beloit (NYSE: RBC), AOS tacitly acknowledged that industry consolidation, and this recent deal between ABB and Baldor Electric (NYSE: BEZ), has made it too difficult to continue on with their own efforts. Facing up to reality and making the best of the situation, AOS is getting a pretty decent going-away prize for this business.

The two companies announced that Regal-Beloit would buy AOS's motors business for $875 million in a combination of cash ($700 million) and stock ($175 million). That is a healthy multiple (1.4x trailing sales) for a business that was the #4 player behind Emerson (NYSE: EMR), Regal-Beloit, and Beldor and relied heavily upon replacement sales (75%) for its business. By comparison, Beldor sold out for about 1.9x sales - Beldor was far larger, more diversified, more leveraged to growth opportunities, and filled a key gap in ABB's motors business.

A.O. Smith management was a little cagey about their plans for the proceeds - talking about using the capital to expand the water products business into new markets and perhaps acquire other products/technologies in that sector. That's almost certainly not enough money to acquire Franklin Electric's (Nasdaq: FELE) water pumps business, but maybe the company would think of taking a run at a large target like Badger Meter (NYSE: BMI) if management felt especially ambitious. What is much more likely, though, is that AOS would target one or more of the numerous small private companies that are involved in heaters, boilers, or tanks - particularly those that have a good business in emerging markets like China or Brazil.

I give AOS management a lot of credit for having the humility and rationality to realize that ABB was putting them in a box that would make their business increasingly nonviable and unlikely to earn attractive returns on capital. That does not mean that it's an awful deal for Regal-Beloit. Quite the opposite actually. Regal-Beloit has the scale that AOS lacked (especially with this deal) and does not seem to be overpaying for what should be a leveragable business. I would expect RBC to able to integrate this deal fairly easily and make it accretive in relatively short order.

Win-win deals are not that common, and certainly seldom come from a major rival getting more active in the space. Nevertheless, ABB's efforts to grow its North American motor business may just end up helping these two companies out if A.O. Smith can put the capital to good use and Regal-Beloit can avoid the footfalls of the new giant.

A Long-Awaited Move From ABB

The idea that Swiss industrial giant ABB (NYSE: ABB) is making an acquisition is about as surprising as Thursday following Wednesday. ABB has been openly on the hunt for acquisitions for a few years now, and most of the surprises about the company's M&A activities have centered on deals that slipped away from the company. On Tuesday, though, ABB announced it had agreed to acquire Baldor Electric (NYSE: BEZ) in an all-cash deal.

The Deal
ABB is paying $63.50 in cash for each Baldor share, a 41% premium to Monday's closing price and a total deal value of $4.2 billion. That is quite an impressive end to a recovery run in Baldor's stock that began back in March 2009 at a price below $11 a share. In fact, Baldor's shares had risen about 55% year-to-date, so ABB is certainly not stepping in and buying an asset that has been ignored by Wall Street. Moreover, at about 14 times trailing EBITDA, ABB certainly does not seem to be underpaying for this company.

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