|Shares Out. (in M):||46||P/E||-||-|
|Market Cap (in $M):||719||P/FCF||-||-|
|Net Debt (in $M):||1,314||EBIT||0||0|
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Baldor Electric (BEZ) is an overleveraged, low-end industrial parts manufacturer that is facing a steep drop in demand that management and the investment community has yet to fully acknowledge. The company produces and sells motors ranging from 1-5 horse power motors for [miscellaneous industrial applications] to  horse power motors for heavy duty oil and gas operations. BEZ's products are sold entirely into industrial end markets, and the sales mix is roughly 50% OEM and 50% distributor. We believe the company has about 40% market share in motor manufacturing in the U.S. and Canada. In an unwise, but seemingly common maneuver in recent years, Baldor made a large, mostly debt-financed acquisition near the top of the bubble in early 2007, acquiring Rockwell Automation's motor manufacturing operations. While this transaction roughly doubled the company's sales, BEZ's debt load jumped to well over 4x debt-to-EBITDA. That level of indebtedness is fine for boom times, but Baldor's business is cyclical and is now enduring collapsing demand. Despite numerous industry data points that point to sales falling off a cliff, Baldor management (and the sell-side) has been slow to acknowledge the unfolding pain. We believe this is chiefly because the company desperately needs to amend its credit agreement before it violates leverage covenants (possibly as soon as Q2-09 without an amendment), so management needs to maintain a show of strength to its lenders. The sharp deterioration in the company's results also undermines management's credibility, as it has projected an "everything is just fine" message (at least relative to similar industrial companies) throughout the downturn. Late last week the company filed an 8-K announcing that it had begun preliminary talks with its creditors for covenant relief as a "precautionary" move. We believe this will prove more costly than management expects. We also think it confirms that management's relatively optimistic assessment of business conditions is unraveling.
The sell-side seems reluctant to slash estimates to realistic levels - in no small part, we believe, because management itself has not really confessed to the depth of the current downturn. (We note that they also still remain in love with the stock: of 9 analysts, 8 have buy ratings on it.) Current revenue estimates are down about 9% y/y. EBITDA is projected to fall only 12%, and EPS are projected to decline from $2.15 in the peak year of 2008 to $1.58 in 2009, before rebounding to $1.81 in 2010. We think these estimates are far too optimistic. Our work suggests that sales are currently running down 20-30% y/y in the industry, which will have a devastating impact on profitability as the company de-levers operationally. Moreover, as we discuss below, Baldor is running at profit margins that are substantially above historic levels, implying a high likelihood of a painful reversion to the mean. We think the combination of an increasingly scary balance sheet (think debt-to-EBITDA over 5x), collapsing sales and a potentially huge contraction in profitability will cause investors to dump the stock. A share price in the $5-7 range seems possible. This would equate to about 7x our EBITDA estimates and about 10x earnings.
We show our financial estimates alongside the Street's consensus estimates below:
FY: Dec 2007 2008 2009 2010
Revenue (us) 1,825 1,955 1,538 1,461
% Change NM 7% -21% -5%
Revenue (street) 1,780 1,780
% Change -9% 0%
EBITDA (us) 325 330 213 201
% Margin 17.8% 16.9% 13.9% 13.7%
EBITDA (street) 289 310
% Margin 16.2% 17.4%
EPS (us) 2.08 2.15 0.64 0.57
% Change -70% -13%
EPS (street) 1.58 1.81
% Change -26% -15%
Net Debt 1,339 1,314 1,230 1,200
Net Debt / EBITDA* 3.8x 5.6x 5.7x
*Note: there are some small add-backs to EBITDA for purposes of the leverage calculation.
We believe that rapidly declining sales, slimmer margins and heightened balance sheet risk will prompt investors to dump BEZ shares. A valuation of $5-7 per share, or roughly 7x estimated EBITDA and 10x estimated earnings seems reasonable.
In addition to the BEZ equity short, another mis-priced security is the company's junior bond issuance ($550 million at face value with an 8.625% coupon), which currently trade for about 80 (implied YTM of around 12.5%). These bonds will likely pay the price for management having to accommodate the company's senior lenders. We think a best case scenario is a 400-500 bps widening after the amendment is finalized. A more pessimistic scenario driven by a loss of confidence in management could involve the bonds' yield jumping to 20-25%, implying 45-55 levels, or 30-40% downside. Baldor's 8.625% bonds are liquid and have ample borrow.
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