Tennant: Financially And Technically Strong (NYSE:TNC)

Tennant Company (NYSE:TNC) manufactures floor cleaning equipment internationally. TNC recently posted solid Q2 FY23 results. They were able to grow their revenues and net income in this quarter. I will analyze its Q2 FY23 results in this report. I believe they are undervalued with a lot of upside potential. Hence I assign a buy rating on TNC.

Financial Analysis

TNC recently announced its Q2 FY23 results. The net sales for Q2 FY23 were $321.7 million, a rise of 14.8% compared to Q2 FY22. I believe higher sales in the Americas, and China was the main reason behind the revenue growth. The revenue in the Americas grew by 21.4% in Q2 FY23 compared to Q2 FY22. I think higher demand for its equipment and parts in North America was the main reason behind the revenue increase in the Americas. The company saw volume growth in China; as a result, its revenue in the Asia Pacific grew by 2.4% in Q2 FY23 compared to Q2 FY22. Talking about its gross profit margin, it was 43.3% in Q2 FY23, which was 37.8% in Q2 FY22. I believe the higher pricing policy that the company adopted in the quarter was the main reason behind the significant improvement in the gross margins. The pricing in Q2 FY23 was 9.3% higher than Q2 FY22 pricing. Due to higher revenue and gross profit, its net income grew by 88.5% in Q2 FY23 compared to Q2 FY22.

Double-digit growth in sales, significant improvement in gross margins, and a significant rise in net income. I think the company delivered a fantastic quarterly result with improvement in every aspect. Now talking about future expectations from the past two financial years, the company’s revenue growth has been poor. In FY21, its revenue growth was in the single digits, and in FY22, its revenue growth was stagnant, but I believe we might see a change in FY23. I think its growth in FY23 might be impressive. I am saying this because, in FY21 and FY22, the company was severely affected by supply chain challenges and high inflation, but in Q2 FY23, there were no such challenges, and we can already see that the company saw solid growth in the first half of FY23. Due to improvement in the supply chain, the company was able to increase its production levels, and the lead times improved. As a result, they reduced their backlog, which helped them grow their revenues in Q2 FY23. They still had $255 million in backlog at the end of Q2 FY23, and given their greater production levels and shorter lead times, I anticipate that this backlog will boost their revenue in the upcoming quarters. In addition, the management’s higher pricing policy might lead to an improvement in margins in the coming quarters. So, I think TNC might perform well in the second half of FY23, and the revenues of FY23 might exceed the FY22 revenues. The management has raised its revenue guidance for FY23, and they are expecting it to be around $1.23 billion, which is 12.8% higher than FY22 revenue. With the increased production level, a healthy backlog, and pricing power, they might achieve the revenue targets. The company has not experienced any solid growth in the last two financial years, and achieving double-digit growth in FY23 might benefit its share price in the coming times. Not only financially, but the company has improved fundamentally. Its cash and cash equivalents by the end of June 2023 increased by 23% compared to December 2022, and its short-term debt and long-term debt have decreased by 10.3% and 7.6%, which is a positive sign. So in my view, TNC is looking fundamentally and financially solid.

Technical Analysis

TNC is trading at the $81.8 level. The stock has been trying to break the $84 level for the last six years. The stock has touched the $84 level five times in the last six years but failed to break it every time. But whenever a resistance zone has been tested multiple times, the influence of that particular zone becomes weak. So I believe we might see a breakout soon in the stock, and if the stock gives a breakout, the upward rally in the stock will be huge. Because the breakout will happen after six long years, and one thing I like about the stock is that even in difficult times, the stock doesn’t crash much compared to other stocks. The stock has been trading in the range of $50-$84 for the past six years, and even in the covid crash of 2020 and in the correction of 2022, the stock didn’t break the level its downward level of $50, which shows that the stock is quite stable. Another thing that I like about this setup is that if we see the price action from the Month of May, we can see that the stock has not made any significant green candle to reach the breakout level. After every green candle was made, there was a brief consolidation for about 15-20 days which is a positive sign. Because generally, when a stock moves up quickly without any consolidation, the chances of a breakout failure increase. But when the stock moves up slowly and steadily, and the chances of a breakout being successful increase, so, in my opinion, investors should keep this stock on the watchlist because the stock might give a breakout anytime.

Should One Invest In TNC?

Institutions own 87% of the TNC’s shares which is a positive thing, and this might be the reason that we don’t see any drastic movement in the stock price even during adverse market conditions. Because I believe when institutions own most of the shares, we see less volatility in price fluctuations.

Now talking about TNC’s valuation. TNC has a P/E [FWD] ratio of 14.68x which is lower than its five-year average of 21.65x and the sector ratio of 17.69x. TNC has an EV / EBIT [FWD] ratio of 12.76x compared to the sector ratio of 15.31x. The ratios show that it is undervalued, and with the company’s growth in the first half of FY23, I think it should trade at a higher multiple. I believe it can trade at a P/E of 17.7x, and if we take its EPS [FWD] of $5.58, we get a share price of $98.5. It shows that there is good upside potential in the stock. In addition, the company’s financials and balance sheet have shown good improvement. So looking at all the positives, I think it might be a good buying opportunity. Hence I assign a buy rating on TNC.

Risk

The company may consider complementing its organic expansion with purchasing related companies or goods as part of its growth strategy. They have made acquisitions in the past, and doing so in the future could offer them valuable chances to expand their company and boost profitability. Through acquisitions, they can broaden the range of the products they offer and increase their goods and services market and geographic reach. However, their ability to expand through acquisitions depends on their ability to find the right companies to buy, integrate those companies into their existing operations, and adhere to the conditions of our lending facilities. When assimilating the operations and products of an acquired business or reaching predicted efficiencies, cost savings, revenue synergies, and profit margins, they may experience difficulties in realigning and integrating corporate activities. Businesses that have been acquired could not perform as planned in terms of productivity, profit, or other metrics. Additionally, they run the risk of acquiring unanticipated liabilities and contingencies related to an acquired firm that are not fully disclosed or detected throughout the due diligence process. If the newly acquired businesses do not produce the anticipated financial outcomes, current or future acquisitions may not be profitable or profitable while increasing earnings.

Bottom Line

TNC is looking fundamentally strong, and they have delivered solid financial results. Looking at their growth, I believe they are undervalued with a lot of upside potential. In addition, the stock is on the verge of a breakout; hence I assign a buy rating on TNC.