This supplier is crucial to booming industries, but the credit rating agencies are missing the story
Before jumping to invest in a new trend, investors need to think about if there may be other ways to get the same exposure.
We’ve always loved looking at not only the OEMs to booming industries, but also the suppliers. Today, we’re looking at one quiet supplier that has been winning from a confluence of trends, but the credit rating agencies fail to see it as a winner. Let’s put their pessimism to the test.
Also below, a detailed Uniform Accounting tearsheet of the company.
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Investors often think about companies in terms of exposure to trends.
They’d be right to think that companies exposed to trends like industrial robotic automation, surgical robotic solutions, wind energy, and the internet of things should be riding massive tailwinds.
That is why investors are paying such a premium for companies like Rockwell Automation (ROK), Intuitive Surgical (ISRG), Aptiv (APTV), and Vestas (CPSE:VWS). But those same investors often miss something important.
Tailwinds alone fail to make a company compelling. When a demand trend begins to appear within an industry, a multitude of companies will rush to throw their hats into the ring and build the products that customers want. This creates tough competition.
To really take off, companies also need to win against their competitors. They need to demonstrate better technology, reliability, and customer service. Not everyone wins that game.
But there is another set of companies that can ride massive tailwinds but without facing the cutthroat competition. These companies win no matter which of the top-line producers become favored by customers.
These are companies like Altra Industrial Motion (AIMC), a supplier of tiny industrial parts that end customers usually don’t think about. Altra makes the actuators, servo motors, industrial brake solutions, and the like, that are essential for companies making advanced mechanized systems.
Because Altra is a key supplier to growing industries, it has grown its own revenue by over 20% each year from 2017-2019, before the pandemic induced a pause.
And yet, despite generating a 25% Uniform return on assets (“ROA”), the rating agencies act as though the company is a high risk to creditors with a BB rating. That rating implies the firm has a 10% chance of defaulting in the next 5 years.
As the Credit Cash Flow Prime (“CCFP”) analysis shows, this pessimism makes no sense. Altra has a significant amount of cash on hand and robust cash flows that comfortably exceed all obligations in each year going forward, except in 2025 when a large term loan comes due. However, by 2025, the firm will have built more than enough cash to manage the payment.
To visualize the strength of Altra’s balance sheet in the coming years, take a look at the chart below. The stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
While managing the 2025 term loan maturity may require some planning, we think Altra should have no issues repaying its debts. Hence, it lands as an investment-grade IG4 on the Valens credit scale.
With access to Valens’ research database, you can see CCFP for thousands of companies. Click here to learn more.
SUMMARY and Altra Industrial Motion Corp. Tearsheet
As the Uniform Accounting tearsheet for Altra Industrial Motion (AIMC:USA) highlights, the Uniform P/E trades at 17.8x, which is below the corporate average of 24.0x, but above its historical P/E of 15.4x.
Low P/Es require low EPS growth to sustain them. That said, in the case of Altra, the company has recently shown a 3% Uniform EPS decline.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Altra’s Wall Street analyst-driven forecast is for 3% EPS decline in 2021 and 12% EPS growth in 2022.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Altra’s $48 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to shrink by 2% over the next three years. What Wall Street analysts expect for Altra’s earnings growth is below what the current stock market valuation requires in 2021, but above that requirement in 2022.
Furthermore, the company’s earning power in 2020 is 4x the long-run corporate average. Moreover, cash flows and cash on hand are more than 2x its total obligations—including debt maturities, capex maintenance, and dividends. Additionally, intrinsic credit risk is 50bps above the risk-free rate. All in all, this signals a low credit and dividend risk.
Lastly, Altra’s Uniform earnings growth is below peer averages, and the company is trading below its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research