Description

I am recommending a long investment in Global Power Equipment (GLPW), which I believe is a relatively low-risk play on the long-term growth of the gas-powered turbine market while the Company’s entrenched services business provides steady and relatively low-risk cash flow.  Some VIC members may recall that GLPW did a stint in bankruptcy between 2006-08—it was felled by the toxic combination of large, unfavorable fixed price contracts and surging input costs in a division that has since been divested, together with a leveraged balance sheet.  The Company is simpler today, and I would contend has lower risk (including no debt), a cogent strategy and a new team to drive the strategy.  The Company’s presentation at an investor conference last month provides a good introductory overview to the business: http://files.shareholder.com/downloads/ABEA-4UISCA/2438844532x0x646939/1a6aea24-5b40-4be7-a641-e72d23c13bdf/20130318%20GLPW%20ROTH%20Investor%20Presentation%20FINAL.pdf

GLPW operates through two distinct and independent business units:  the Products Division designs, engineers and manufactures gas turbine auxiliary equipment, including filter houses, inlet systems, exhaust systems and diverter dampers, which it sells mainly to OEMs, engineering/construction firms, and operators of power generation facilities.  General Electric, Siemens, Alstom, and Mitsubishi Heavy Industries are among the division’s largest customers.  In 2012, Siemens and GE (gas turbine OEMs) each accounted for roughly 15% of consolidated revenue.  Basically, GLPW produces niche components for gas turbine systems, markets in which they typically enjoy a leadership position.  A majority of the Products Division’s contracts are fixed price contracts, i.e. they bid against other contractors based on end-user specifications for a particular turbine system.  The Products Division is both cyclical (tied to the construction of new gas turbine power plants) and lumpy.  With the weak economic recovery from the financial crisis and concomitant sluggish power demand, the industry has been cyclically depressed in recent years.  The Products Division enjoys relatively low capital requirements since it outsources a considerable amount of manufacturing while performing a higher mix of final assembly and fabrication in-house.  In 2012, the Products Division generated revenues and operating income of $193.7 and $9.3 million, respectively.  The Company has guided 2013 Products Division revenue to a range of $185-205 million.

GLPW’s Services Division (called Williams) provides maintenance and modification services for utilities, primarily nuclear power plants. Williams often serves as a primary contractor to their customers on capital projects and facility upgrades.  A preponderance of the Services Division’s projects are upgrades and ongoing maintenance of (increasingly aged) nuclear power plants.  GLPW is one of a limited number of companies qualified by the US Nuclear Regulatory Commission to perform comprehensive services in nuclear power plants.  In 2012, the biggest customers of the Services Division were Southern Nuclear Operating Company (16% of consolidated revenue) and Tennessee Valley Authority (14%).  Last year, 90% of Services Division contracts were structured as cost-plus, which limits financial risk insofar as it passes the costs of project delays and any increases in raw material prices through to the end user.  In contrast to the Products Division, the services business is relatively steady (over the medium term since discrete projects can drive large quarterly fluctuations) and sticky given the regulated nature of the business and operators’ aversion to changing service providers so long as they are performing reasonably well.  In 2012, the Services Division generated revenues and operating income of $269.2 and $11.2 million, respectively.  The Company has guided 2013 Services Division revenue to a range of $300-310 million, nearly 70% of which was already booked in backlog as of a month ago.

The CEO, who joined in July 2012, has a relatively straightforward strategy that entails: 

• Tuck-in acquisitions (and internal development) of additional niche component suppliers in the turbine space, thereby expanding the range of products GLPW can provide to its existing customer base (especially in industrial turbines, which are enjoying better growth than the utility space)
• Investing in adjacent technologies that broaden its addressable market, e.g., the gas separation/cleaning and heat transfer markets, which utilize similar/complementary technologies
• Drive efficiencies and cost reduction in existing businesses through the implementation of LEAN and other process and technology enhancements
• Build out GLPW’s presence on the ground in higher-growth emerging markets
• Return cash to shareholders while maintaining financial flexibility

Central to the growth thesis for GLPW is expansion in the gas-fired electricity generation market, which is expected to capture up to 60% of new domestic capacity over the next 20 years, substantially higher than gas’s historical penetration rate.  With abundant, cheap gas (even if prices rise modestly in coming years) and an inexorable tightening of environmental requirements that will increasingly marginalize coal-fired facilities, this is a long-term tailwind, even if the cycle is not currently where GLPW shareholders might like (hence the current opportunity in a short-term oriented market).

As intimated above, the near-term outlook for power generation construction remains soft, particularly in the US.  However, over an intermediate time horizon, there is significant need for additional capacity to meet growing demand and replace aging equipment.  In addition, environmental regulations will increasingly make it more economical to replace aging plant rather than retrofitting.  In summary, price, efficiency, safety concerns about nuclear power plants, environmental concerns about coal plants all favor the growth and continued share gains of gas-fired power generation over other alternatives.

At an EV of $230mm, GLPW trades at ~8x 2012 Adjusted EBITDA of $28.5 million, not especially cheap to be sure.  However, recent results reflect continued sluggish demand in the Products Division as its end markets continue to be cyclically weak.  Under a normalized business cycle, I estimate that GLPW should be able to generate mid-cycle EBITDA of at least $50 million or more (based on historical results and normalized margins).  At an 8x EBITDA multiple (based on low maintenance capex of ~$3 million and thus solid FCF conversion), GLPW could be worth $25-30 per share (where it last traded in Spring 2011).  While timing the cycle is difficult, the current dividend (2.4% yield), modest share repurchase program and reasonable FCF yield (assuming normalized working capital), coupled with the conservative balance sheet, allows you to get paid while you wait.  Such factors also limit the reasonable downside in GLPW.  Given modest downside risk and substantial potential upside in 2-4 years, GLPW seems to us to present an attractive risk-reward proposition at the current share price.

Catalyst