Description
Altra Holdings, Inc. (AIMC) manufactures and sells clutches, brakes, gear drives, engineered couplings, bearing assemblies, power transmission components, and brakes to a wide range of end markets including energy, general industrial, material handling, mining, transportation, and turf and garden. Altra does not have large exposure to any one customer or any one market, and it’s exposure to the US automotive industry is only 3% of revenue.
The company was formed in late 2004 with the acquisitions of PTH and Kilian. Genstar was the private equity sponsor, and the management team bought stock using their own money. Acquisitions of Hay Hall and Bear Linear followed in 2006, and in late 2006, the company had it’s IPO. Altra acquired TB Wood’s in April of ’07, and Genstar has since sold all of their shares removing any overhang.
If the management team executes on its business plan, integrates TB Wood’s successfully, and continues to beat expectations, we believe the stock is cheap. The following will outline the bull case for Altra:
- Management experience: The CEO, Michael Hurt has 40 years of experience in the mechanical power transmission industry. He was the former CEO of TB Wood’s where he increased revenue and improved operating margins. Much of the management team including the President and COO, Carl Christenson has worked together at TB Wood’s. Most of Mr. Hurt’s net worth is in Altra stock, and we believe that he is focused on shareholder value.
o An additional point here is the company’s use of the Altra Business System. The company tracks every manager and every division on a monthly basis for a series of metrics relevant to that person’s job. While this does not guarantee that problems won’t arise, it does mean that the management team is aware of any potential issues quickly. It also provides every manager the opportunity to be evaluated objectively.
o Another area of success for the management team is the development of new products (defined as developed within the last 3 years). In 2005, new products accounted for 6.8% of revenue. This rose to 9.5% in ’06, and has been running around 12.5% in ’07.
- TB Wood’s deal: According to company guidance, TB Wood’s should be $.15 - $.20 accretive by 2008. Our checks indicate that the integration of this business is proceeding faster than expected and that cost saving estimates may have been conservative. They should get $8MM in savings next year from letting some of TB Wood’s executives go, consolidating the salesforce, and reducing public company costs. We are modeling a lower synergy amount just to be conservative.
- Outsourcing: Altra is saving 40% - 50% by sourcing in China. Currently, they are getting 15% of their COGS from China and think they can double that in the next few years. This could add 7% to EBIT margins. Given that 2006 EBIT margins were 9.8%, and the company is saying they can get to 18% margins by 2011, just by getting this one thing right, they can get close to their goal.
- Selling into China. Altra is also producing and selling product in China. Much of this business is elevator brakes. They doubled this business in ’06 and believe they can double it again in ’07.
- Opportunity to continue to beat estimates. Altra has beaten estimates in both 1Q and 2Q primarily on higher than expected revenue. The street was expecting organic revenue growth of 5% - 6%. Organic growth was 7.0% in 4Q ’06, 8.1% in 1Q ’07, and 9.6% in 2Q ’07. The 2Q number is the first one that includes TB Wood’s which had no growth in that time frame. A better management team and access to Altra’s distribution system should help.
- Strong free cash flow generation: Altra should have free cash flow around 115% - 120% of net income due to a capital expenditure budget that is below current D&A and due to incremental improvements in working capital.
Here are our estimates which are based on organic growth of 5% - 6% and conservative synergy estimates. We are also making conservative assumptions on the benefits of further outsourcing. Note that ’08 revenue growth is greater than 5% due to the acquisition of TB Wood’s in ’07.
2007E 2008E 2009E
Revenue $590 $660 $690
EBITDA 91 109 118
EPS 1.05 1.37 1.70
FCF/Share 1.17 1.61 1.99
For this level of growth in EBITDA and EPS, we are comfortable using an 8 multiple of EBITDA and a 15 multiple of EPS. This gets to values around $25 based on ’09 numbers, or approximately 50% upside from current levels. This could happen in late ’08 when people start to focus on ’09 estimates. Note that a valuation based on free cash flow would imply a higher stock price.
We see 2 potential negatives:
- Industrial exposure: Many of Altra’s customers are tied to GDP growth or the economy in general. The stock tends to be volatile, and we would expect that most industrials won’t trade well if we have a recession. It is worth noting that Altra’s end markets are highly diversified, and that the mining business tends to be long-cycle (especially with higher commodity prices). In addition, the company is showing strong results in defense, mining, and material handling, and is gaining share in turf and garden as well.
- Leverage: As of June 30, Altra had $291MM in net debt, and much of this is high cost. They paid off $23MM of the 11 ¼% in February, and have bought back other debt in the open market. Altra should generate over $120MM of free cash flow between now and the end of 2009. If they use it to reduce debt, they can get their debt/EBITDA down to 1.5x.
Ultimately, this will need to be an execution story. If management can continue to develop new products, leverage their SG&A and distribution system, cut costs at acquired companies, and continue to improve margins with greater outsourcing, the stock is cheap at current levels.
Catalyst
- Beating earnings estimates through greater than expected organic growth.
- Greater outsourcing should drive operating margins higher.
- Integration of acquired companies and putting acquired product into a better distribution system.
- Use of free cash flow to reduce leverage.