Description

Allient (formerly Allied Motion, which has been written up on VIC) is a good business in a good industry – niche industrial motion / power / controls. Allient has returns on tangible capital of 20-25%+ (which should expand over time), and similar businesses are also the same. Allient is also run by an owner / operator – Dick Warzala – who owns 10% of the company. Dick has been running the business for 20 years and comes from Danaher. Under his leadership, the company has never taken an impairment (except for one in 2009 for obvious reasons) despite its acquisitive history and EBITDA rose from $3 million in 2003 to $70+ million today. 

At ~$26.75 per share, the company is being offered at ~9-10.7x normalized earnings (defined as after-tax EBIT plus amortization and excess depreciation). This is despite the fact that the business (1) is connected to attractive end markets, (2) has shown organic growth of 4-5%+ per year for ~10 years, and (3) operates in a niche that results in very sticky customer relationships, attractive margins, and returns on capital. Over a 3-4 year period, I think an investor can earn 20%+ IRRs at the current price. 

1. Background

Allient makes motion, controls, and power systems that go into a variety of industrial products. The industry includes companies like Ametek, Parker Hannifin, Altra Industrial Motion, and Regal Rexnord. The industrial motion/components market is extremely large and very fragmented and the industry is characterized by significant amounts of M&A – every key player has M&A as a key strategy.

Allient is diversified. Medical and Aerospace & Defense combined represent close to ~30% of sales and are generally stable and growing markets. 44% of sales come from industrial end markets that are generally speaking tied to industrial automation, which I think we can agree is a growing end market that should continue to do so for a long time to come - more automation means more robotics (which means more Allient motors) and more electrical demand (which means more Allient power systems). The remaining portion of the business comes from a variety of vehicle / equipment related end markets whose content ranging from automation (“AGV”), improved / more efficient HVAC systems, and general power / electrical needs are growing.

As a result, Allient has shown attractive organic growth of 4-5%+ per year for the past decade. Notably, this has outpaced each of the peers mentioned above.  

The business itself is also fairly diversified geographically, with roughly 40% of sales coming from overseas. Allient is relatively insulated from downturns in any one market, whether it be geographic or end market specific.

2. Niche motion / controls businesses are good businesses for a few reasons:

• They supply products that generally speaking are low cost relative to the end product that is sold;
• The supplied products have a very high cost of failure (if they don’t work, the end product does not work as intended);
• There is extremely high customization that goes in to the product design, and sales cycles are very long. This results in even stickier customer relationships;
• Once a product is “designed in” to a given customer’s product, the switching costs are very high;
• And in effect the motion / controls business earns a recurring revenue stream for the life of the customer’s product cycle (typically a few years+)

As a result of these factors, Allient earns attractive returns on tangible capital (20%+ which has been the case for over a decade). Margins are also decent with operating margins of 10%+. Pro forma for savings discussed later, operating margins are closer to 12% and the company aims to expand these to the mid-teens over the next few years.

3. Allient has undergone two fairly dramatic transformations over the past 10 years

First, a decade ago, the company derived ~50% of its revenue from customers in the vehicle end market (products like ATVs, marine products, agricultural equipment, construction equipment, RVs, etc.). Fast forward to today, and these end markets only account for ~23% of sales thanks to various acquisitions and organic expansion elsewhere.

Second, the company previously only used to supply motion products (that is small component brushless motors, for example). As a result of the growth in end markets due to acquisitions and organic growth, the company now supplies controls equipment and power equipment alongside their motion products and management has positioned the company to be a “complete solutions provider”. The same strategy has occurred at Ametek and Parker Hannifin, and recently Regal Rexnord purchased Altra Industrial Motion as part of their move to the solutions provider model as well. This is a well-known strategy in this industry.

Providing integrated solutions results in a much stronger company as (1) the business is able to design applications that previously the customer would have had to use a number of suppliers for (which creates a headache), (2) because the business can be more of a “sole source”, it makes the customer relationships stickier, (3) switching costs are higher the more product you supply, and (4) integrated solutions simply command a higher margin given their more customized nature. Particularly with regard to (4), the high customization associated with Allient’s products also significantly insulates the company from competition (relationships take years to develop and price is simply not the main consideration).

In conjunction with the furthering of this strategy, management recently held their first ever investor day in which they laid out a goal of getting to $1 billion in revenue and high teens adjusted EBITDA margins / mid teens operating margins. As far as I can tell, there is nothing that prevents this from being achieved, though have not underwritten this case because at the current valuation it is simply not needed to do well (it’s a free option).

4. Valuation / Discussion:

In 2023, the company earned roughly $51 million. In Q1 2024, SNC manufacturing was acquired and in late 2023 Sierramotion was acquired. Together, these generate roughly $2 million of income (rough guess). 2023 adjusted profits are therefore ~$53 million. *Note that Q1 annualized profits despite a 6% organic decline are more or less at this level. Pro forma for a restructuring plan announced last year (discussed more below), normalized earnings are ~$61 million. Net debt today is ~$200 million. At ~$26.75 per share, the EV is ~$650 million. The multiple is therefore ~10.7x.

The business is being offered at this multiple largely because management essentially guided for a MSD organic sales decline this year. This is not Allient specific – basically every other peer has reported the same, and “destocking” across the industrial space is not unheard of right now. In my eyes it is simply a matter of “when” Allient’s end markets will recover and not “if”.

At 15x earnings, the company is worth $915 million. The company will probably generate somewhere in the range of $80-90 million of cash over a 3 year period. The company is also probably going to get back to historical inventory turns of <3.5x which is another ~$10 million of cash. So, at the end of the three year period the business is likely to be worth $915 million - $200 million + $90-100 million = ~$810 million. This will also put the business at close to 1x net debt / normalized EBITDA so it is likely management will have made another acquisition which would be accretive to this value.

Nonetheless, at $810 million, the company is worth ~$48.3 per share which is a ~22% 3 year IRR on what should be relatively conservative assumptions (the business takes 3 years to recover, a modest multiple, more or less trough levels of cash generation for 3 years, assuming no acquisitions for what has historically been an acquisitive company, etc.).

A few other comments -  

Restructuring:

Last year, management hinted that they will embark on a restructuring plan to simplify the business from the acquisitions they’ve done over the past few years. This was set in stone in Q1 of this year. My understanding is that this plan is largely addressing acquisition integration - the company really did not spend much time integrating acquisitions but rather prioritized positioning the company for its “complete solutions provider” vision and focused on making the right acquisitions in the right end markets. Accordingly, there are seemingly a number of low hanging fruit redundancies (factory rationalization, SG&A rationalization, etc). Some comments on this initiative are below:

Q4 2023: “I'll bring it up a little bit, I think that you even asked the question before is that as we did all the acquisitions, you could see revenue line going up, but you also saw the SG&A expenses going up along with that? That is correct. And at some point, you have to you have to leverage those increased cost to either grow revenues, earnings some more, or to find ways where you can realize some synergies. And that percentage reduction should go down. You should actually see synergies there and start to leverage that.”

Q1 2024: “Our strong commitment to our strategy guides all of our key decisions. With the unveiling of our new strategic model, Simplify to Accelerate NOW, we embark on a journey aimed at refining our organizational structure, eliminating redundancies, and optimizing our operations. In pursuit of sustained earnings growth and increased cash generation, our teams have identified key strategic actions for this year and into 2025. Realigning and rationalizing our footprint represents the largest opportunity, but also the most complex. This includes the consolidation of our brands under the Allient banner to include our motion controls and power technologies.”

Over the next two years, management thinks this plan will result in savings of $10 million+. So, pro forma for these savings, after tax earnings works out to roughly $62 million.

Other factors:

Acquisitions

A word on the company’s acquisition strategy. Astute readers will point out that returns on incremental capital from acquisitions have been just Ok – by my calculation, returns on total capital using gross intangibles have been ~10%. A few things about this:

• This is an unlevered figure. Returns on incremental equity have been higher.
• While management plans to continue making acquisitions, at the current valuation, all that really matters is determining whether management destroys value in their acquisition strategy. History would show that they have not.
• It’s not a perfect measure, but Ametek and Parker Hannifin have returns on total capital using gross intangibles of low double digits. These are the best businesses in the space. So - ALNT management doesn’t seem too far off here.

“Growth spend”

Industrial businesses like these are very capital light – maintenance capex is no more than 1.5% of revenues. As a result, a lot of the “growth expense” is really located on the income statement in the form of R&D. Historically, the company has grown organically at ~4-5% and therefore it seems clear that if you wanted to assume some level of “maintenance R&D”, the “real” valuation multiple is much lower than the 10.5x referenced above. I would also highlight a comment that management made last year at their investor day: “A lot of [investments in operating expenses] has been going on for the last 3, 4 years. And we think we've built the platform, if you will, to absorb the next $100-200 million in growth. So we will not have to spend in those areas as aggressively as we have in the past to accomplish that growth”. Clearly, the business is being managed for cash flows tomorrow and not those in the rear view mirror.

On R&D specifically, ALNT’s R&D expense is well above every competitor – the company spends ~7% of sales on R&D while the next highest peer (Ametek) spends 5% on sales. Every other peer spends low single digits. This is particularly notable as when you look at organic growth rates for each business from 2014-2023, it’s clear that this extra spend is benefiting ALNT:

• Allient: 4-5% CAGR
• Ametek: 2.3% CAGR
• Parker Hannifin: 1.9% CAGR
• Regal Rexnord: -0.5% CAGR

If you simply adjusted ALNT’s spend to be on par with Ametek (which is still high on a relative basis), really you would be purchasing ALNT at ~9x earnings.

Relative Valuations

Not that I base my investment case on it, but it is worth noting that every public peer trades at much, much higher valuations. Ametek, Parker Hannifin, and Regal Rexnord trade at 20x, 16x, and 13x EBITDA, respectively while ALNT trades at <10x. Altra Industrial Motion (a direct competitor of ALNT in certain markets) was also acquired by Regal Rexnord last year at 13x EBITDA. To be fair some of these businesses deserve to trade at premiums – particularly Ametek which is a fantastic business; all of these also have higher margins. That said, I think it is clear that ALNT does not deserve to be priced at <11x after tax earnings – a valuation that’s usually on par with very mediocre businesses in mediocre industries.

Also - ALNT historically traded at ~11-12x EV/EBITDA. At the low end this equates to 15x my earnings figure, so it doesn’t appear that I’m out of line with history. Further, ALNT is simply a better business today (less vehicle concentration, able to offer complete integrated offerings with higher margins, etc.) than it was pre-covid.

Using 2023 as a baseline:

Since I’m sure there will be questions, I will address it now: management thinks this year will see a revenue headwind of $35 million (a 6% organic decline) relative to 2023 as 2023 saw elevated shipments as customers reduced orders but supply chains began easing. So yes, you could say that 2023 earning power was abnormally high. However: 

• In the recently reported Q1 2024, which included a 6% organic decline, annualized operating income was actually more or less in line with the above number;
• While 2023 did see elevated shipments, it also saw lower margins in certain areas due to contract pricing delays (in the vehicle segment, for example);
• Europe has essentially been in a recession / downturn for over a year, and that’s 26% of sales;
• My projections typically assume normalization in 3 years. Given historical industry cycles tend to last <3 years outside of major recessions, it seems quite reasonable to me to expect that the business will get back to 2023 levels of organic revenue at some point in this timeframe. One could also project market growth (which is GDP+) from 2019, and you would get to 2023 levels of revenue in ~2027 using 2.5% market growth (lower than history, and lower than ALNT’s historical organic growth rates).

So, yes while management expects that organic revenue will decline and that margins may suffer relative to 2023, it seems fair to assume that at some point over the next few years the company will make up this 6% organic decline in revenue purely due to growth in its end markets.

5. Debt as a risk / Downside:

The company has ~$200 million of net debt today. On adjusted LTM (for the recent acquisition and some savings from the above restructuring), that represents ~2.35x net debt to adjusted EBITDA. This is a little high for my liking, especially when we are entering an uncertain environment. Even so, there are a few things to note that alleviate much of my concern:

• The debt doesn’t mature until 2029, which provides significant runway should the market not recover soon;
• Covenants on the debt are at a 4.25x leverage ratio. Assuming no cash generation, that means EBITDA must fall by 40%+ to break covenants. Cash generation alone will reduce net debt by ~$20-30 million over the NTM (assuming some working capital release) so breaching covenants I think is incredibly unlikely, especially when management has stated that their priority is to reduce leverage. Pro forma for this, and assuming a 45% decline in EBITDA, leverage is 3.7x;
• Interest coverage must be a minimum 3x. Annual interest expense today is roughly $14 million though is currently protected from swaps that mature in December 2024 and 2026. Assuming $30 million of debt paydown between now and the end of the year, annual interest expense (without any swaps) will be $15 million. Assuming EBITDA falls 45% to $47 million, interest coverage is still >3x

In terms of downside, I see the following:

Over the LTM (and during CY 2023), the company has received orders of ~$520 million (an organic decline of 10% from 2023). This is during a destocking period, so either this is reflective of “true demand” or is lower than actual demand as customers continue to hold off on new orders in favor of reducing backlog (my bias is that it is the latter). Add in recently acquired Sierramotion and SNC manufacturing revenue, and we’re at ~$555 million of revenue based on the LTM order trends.

2023 gross profit, adjusted for these acquisitions, was roughly $195 million. Let’s assume that gross profits fall at twice the rate of revenues so gross profit will be $156 million (28% gross margins). This is probably conservative since fixed manufacturing overhead is ~15% of COGS.

Furthermore, let’s assume that operating expenses are completely fixed with the exception of selling expenses (these tend to move in line with revenues). That means operating expenses will be ~$125 million. As a result, EBITA will be roughly $31 million. Add in $10 million for the restructuring plan (which should be realized within 1.5 years), and EBITA becomes $41 million. After tax earnings at that rate will be roughly $38 million. At 15x earnings, the company should be worth $570 million. Less $180 million of net debt (assuming some working capital release and debt paydown) and you get $23.2 per share of value. From $26.75 per share, that’s <20% downside.

*Notably, this analysis assumes EBITA equal to 2020 levels pre-savings which ought to be a conservative measure of downside.    

DISCLAIMER: The Author currently holds a long investment in the securities of Allient (Ticker: ALNT) and stands to benefit should the price of the security rise. The Author may buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note and disclaims any obligation to update such information. The views expressed in this note are the sole opinion of the Author, which may change at any time. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the above note. This written note should not be construed as a recommendation to buy or sell any security or as investment advice.

Catalyst

Recovery in end markets

Progress on providing more integrated solutions 

Completion of rationalization program