Description

Manitowoc (MTW) is a poster child of the late 2018 market meltdown – a levered cyclical with exposure primarily to construction and general industrial end markets.   The stock has fallen in excess of 50% from its Jan 2018 highs, despite enviable execution and continued strong operating results. We believe the market thinks current results are close to peak and are valuing the business as such.  While we acknowledge the business can be economically sensitive, we believe investors are ignoring a host of industry and company specific catalysts that should allow the business to perform materially better over the next several years regardless of the cycle.  These catalysts include: exit of one of their largest competitors from the market, refinancing of high cost / restrictive debt, new product launches poised to capture share, premium price positioning in the market supported by innovation and price increases, declining steel prices, and potential reprieve from tariffs.  We believe MTW is trading for between 3-5x normalized FCF. At 10x normalized (where the stock was trading only a year ago), we believe MTW has the potential to more than double. In a more aggressive view of normalized, and if management can hit its longer-term operating margin targets, we see potential for in excess of a triple.  Management appears to agree, having bought nearly $1.5M of stock in the last year at levels meaningfully higher than today’s prices.

Manitowoc History:

Manitowoc has been producing cranes for nearly 100 years. The business has typically been boom / bust.  In boom periods of economic activity and construction the business does well. This is reflected in Manitowoc’s historical financial statements:

In 2007, in the largest peak in the company’s history, Manitowoc diversified by buying a food service business (now Wellbit).  In the years to come, the combination of economic recession and poor operational performance led to a smaller market for cranes as well as smaller market share for Manitowoc.  By 2016, shareholders had enough, and the “good” food service business was spun off from the “bad” crane business. To add insult to injury, the bad business took out leverage to dividend cash up to the good biz.  The company raised debt in the absolute bottom of the credit market, issuing $300M notes with a 12.75% interest rate and restrictive covenants.

In conjunction with the spinoff, MTW brought in a group of operationally focused executives from Gardner Denver, who had previously worked together at Wabco.  We believe Barry Pennypacker and lead operational execs Aaron Ravenscroft and Les Middleton have done a phenomenal job operationally. They have improved margins substantially in a flat / down market, revamped the product portfolio, and substantially reduced costs and increased operating efficiency.  We’d note that when Barry left Gardner Denver, the stock fell in excess of 10%, largely due to the positive reputation he had garnered with investors. All our checks with folks in industry have been excellent, especially around quality of new product launches and customer service. This operational performance is perhaps best illustrated against Terex:

Terex recently decided to shut down their mobile crane operations and sold their money losing European operations to Todano, another player in the market.  We believe this consolidation and removal of a previously price undisciplined competitor should eventually help to restore a better pricing environment and aid in margin recovery.

Industry Backdrop:

Despite recent improvement in MTW’s results, the crane market is by no means healthy.  This is best appreciated going product by product. The company’s disclosures are limited – our best estimate is that Manitowoc’s crane sales break out today as follows:

·         Tower Cranes (30% of revenues) – Used in the construction of commercial and residential buildings, mostly in Europe.

·         All Terrain Cranes  (20% of revenues) – work horse cranes that are used in a diverse range of applications and end markets

·         Rough Terrian Cranes (15% of revenues) – cranes specially designed to be used in off-road applications – e.g. oil & gas, mining, etc.

·         Crawler Cranes (7%) – very high capacity cranes used mostly for big infrastructure projects (e.g. bridges, wind farms, etc.)

·         Others (7%) – Mostly smaller cranes used in general construction and industrial activity

·         Aftermarket (16%) – spares and aftermarket services, higher margin

We believe just about every crane type, with the exception of Tower Cranes and perhaps All-Terrain cranes, are well below normalized levels. Historically Crawler Cranes and Rough Terrain Cranes have been Manitowoc’s biggest businesses.  Today they are particularly under-represented.

At a high level, overall crane sales are depressed, mostly due to hangover that still exists from the 2007 peak (construction related) and 2012/2013 peak (oil related):

We believe the parts of the market that are particularly depressed happen to be those where Manitowoc has the strongest product portfolio.  Industry data for cranes is closely guarded by the group trade association. Todano, Manitowoc’s primary competitor in Rough Terrain Cranes, releases the best data.  We believe Rough terrain cranes are more than half below normalized levels:

Crawler sales are also particularly depressed.  MTW released a chart without units in their S-1 post the spinoff of their food-service business.  As of 2015 crawler demand looked okay:

We believe sales of crawlers in 2016 and 2017 fell to levels approaching those in 2010.  Most the strength in 2014 and 2015 was due to the release of MTW’s breakthrough variable counterweight technology that allowed them to take substantial share in the market despite still muted conditions.

Why is the market still so depressed if the economy is so strong?

Cranes last a very long time.  Rough Terrain and All Terrain cranes typically last between 6-10 years and crawler cranes even longer (as much as 20).   Thus, unlike some cyclical markets, the hangover from a prior peak can be especially painful and last well beyond an economic recovery.  For this reason, we view normalized less as a function of the economy and more as a function of replacement demand, which can be out of whack with new demand for many years, as we believe the case is today.

We believe that many of the cranes that were sold in the 2006-2008 peak are finally beginning to age out of the fleet and will begin to create replacement demand.  Timing this is tough, but makes sense intuitively – because equipment lasts so long, fleet age is often a more important driver of incremental demand than how strong the cycle is, as excess capacity from previous cycle highs can be absorbed for a substantial period of time before creating incremental demand.

Another issue that has existed in the market, especially for rough terrain cranes, is that newer environmental standards in the US for cranes to run on low sulfur fuel have not been adopted in emerging markets.  This has resulted in a glut of used rough terrain cranes, which would typically leave the US for emerging markets, being trapped in the US. Recent legislation in Mexico and contemplated legislation elsewhere in South America should eventually alleviate this issue.

Data on average fleet age is hard to come by, but based on utilization rates, rental company commentary, and firming used crane prices, we believe it’s a matter of when, not if, we eventually see some demand from the replacement of aging fleets.

Improving technology and retiring experienced operators may also spur new demand:

Another dynamic that we believe will drive continued crane refresh is the substantial improvement in technology with crane operation that makes it much easier for unskilled workers to operate a crane.  Driving a 10-20 year old crane is not very easy. You have a couple joysticks, and radio, and your experience to lean on. See the video below for a typical crane cab interior in operation today on MTW’s major competitor:

https://www.youtube.com/watch?v=wZfwPs9N4A4

If you watch the first couple minutes you will get a pretty clear view of how this works and the skill / experience involved in doing this safely.  Part of this understanding comes from exciting and intuitive technology like this:

https://www.youtube.com/watch?v=cBKMyI38r14

More recently, Liebherr has entered the 1980s with their introduction of a console system that resembles Microsoft DOS.  Still not the best user interface but certainly an improvement:

https://www.youtube.com/watch?v=em78K6xAoZM

Manitowoc, on the other hand, is a couple decades ahead, having invested more heavily than competitors in something approximating more modern technology (but still dated by other interface standards).

https://www.youtube.com/watch?v=UuaedHIUSwY

https://www.youtube.com/watch?v=u_oMeH66SOw

Valuation:

We believe MTW is currently trading at a 11.5% FCF yield and 6x ebitda on well below normalized levels.

Figuring out midcycle in a business like this is not easy – given very long crane life and strong payback in peak periods, sales have generally wildly overshot on the upside and on the downside.

Based on detailed data from Tadano and other industry sources, we estimate units of Rough Terrian and crawler cranes are less than half their normalized levels, defining normalized as average units shipped from 1997 to 2017:

We think management’s long-term margin goals of 10% operating margin, while aggressive by historical data, are realistic given the major improvements to the operational footprint made and continuing to be made by the new team, as well as a more consolidated industry.  We contemplate two scenarios, one where revenues improve marginally from today’s levels and operating margins increase to 7%, and a second where revenue improves more substantially closer to, but still below, the last 20 year shipment average.

At 2.2B of revenues and an 7% operating margin, we see EBITDA of approximately 230M and a valuation of less than 5x FCF.  Applying a 10x FCF multiple on these numbers would get you to roughly a double from here.

In a more aggressive scenario of normalization, where revenues increase 50% and the company hits their operating margin targets, the stock would be trading at less than 3x FCF.  At 8.5x FCF the stock would be a triple from here.

We think we will eventually at least hit the low end of this outcome while accruing a nice double digit FCF to the equity while we wait.  That said, clearly an economic slowdown would delay this outcome – this could be offset (potentially more than offset) by stronger infrastructure spending, especially for big projects like bridges, which rely on very expensive and high margin crawler cranes.

Catalyst

Recovery in crane markets

More rational competitive environment

Market share gains

Continued mgmt execution