While I never let my personal feelings get in the way of my investment decisions, I do have emotional ties with certain companies. One of those firms happens to be The Timken Company (NYSE:TKR), a business that’s focused on the production and sale of products like engineered bearings and power transmission products. This is because the firm’s headquarters are located only about 20 minutes from my house. I have driven by the business more times than I can count. In short, it is an integral part of not only the state I live in, but also my local community.
Even though I don’t let personal feelings get in the way of my analysis, I am happy to say that I have generally been bullish about the company in recent years. A little over a year ago, in April 2023, I ended up writing a bullish article about the firm. Fundamentally speaking, the company was doing quite well at that point. And since I had written a bullish article about the firm previously, shares had seen an upside of 23.7% compared to the 5.6% rise achieved by the S&P 500. Even with that increase, I viewed shares as being fundamentally attractive and cheap enough to warrant additional optimism. This led me to reiterate the ‘buy’ rating I had on the stock at the time.
Since then, things have not gone exactly as I would have hoped. Yes, shares are up another 10.1%. However, that pales in comparison to the 21.6% rise seen by the broader market. As disappointing as this shortfall is, I am happy to say that shares remain cheap and management continues to achieve strong performance. Some of the weakness, however, likely comes from analysts that have a rather negative view of the business in the near term. You see, before the market opens on April 30th, management is expected to announce financial results for the first quarter of the 2024 fiscal year. Revenue and profits are expected to decline year over year. But that’s not terribly surprising when you consider that management also expects some contraction in the firm. But even with this pain anticipated by market participants, shares are attractive enough to justify the ‘buy’ rating in my view.
I’m not worried about the short term
Given the return disparity achieved by shares of The Timken Company compared to the broader market, you might think that the company had a difficult 2023 fiscal year. But that couldn’t be further from the truth. From a revenue perspective at least, management has done quite well. Sales last year totaled $4.77 billion. That’s 6.1% higher than the $4.50 billion generated in 2022. And as the chart below illustrates, it represents a continuation of growth seen from 2021 to 2022. Digging into the data a bit more, it’s worth noting that most of the increase in revenue achieved by management came from acquisitions. Net of divestitures, acquisitions added $246 million in revenue to the company’s top line. But this doesn’t mean that organic growth wasn’t there. Organic revenue increased by $50 million year over year, even as the company saw lower shipments of its products. This was because of higher prices levered onto customers. Interestingly, the picture would have been even better had it not been for $23 million worth of foreign currency fluctuations that negatively impacted revenue.
Looking into the picture a bit further, we can see some results based on the different segments the company has. The largest of these is the Engineered Bearings segment, which accounted for $3.26 billion in revenue last year. This was up $165.1 million, or 5.3%, compared to what was generated in 2022. But almost all of this was attributable to acquisitions. If we strip these out, revenue would have risen by only $3.4 million. The real growth, from an organic perspective, came from the Industrial Motion segment. Revenue of $1.51 billion was $107.2 million, or 7.6%, above what it was in 2022. Acquisitions accounted for $59.8 million of this, after stripping out divestitures. $1.1 million of a game was attributable because of foreign currency fluctuations. Organic revenue, meanwhile, grew by $46.3 million thanks to higher pricing across its product lines and because of higher sales volumes.
Although revenue increased year over year, profits took a small hit. They declined from $407.4 million to $394.1 million. The good news about this is that the pain for the company really came from two non-core things. First, the company went from a $9.3 million benefit involving non-service pension and other post retirement costs in 2022 to a $24 million expense in 2023. The second is that interest expense grew from $74.6 million to $110.7 million. This came about even as net debt grew from $1.62 billion to $1.98 billion. And at the end of the day, that really comes down to higher interest rates. But with those slated to start falling before too long, this is transitory in nature.
Other profitability metrics defied the downward pressure that net profits experienced. Operating cash flow, for instance, managed to increase from $463.8 million to $545.2 million. If we adjust for changes in working capital, we get a slightly smaller increase from $632.5 million to $656.6 million. In addition to this, we should also be paying attention to EBITDA. It managed to grow from $855.9 million to $939.7 million. Management also keeps track of adjusted earnings per share. This figure totaled $508.1 million last year, which was up from the $480.3 million reported for 2022.
When it comes to the 2024 fiscal year, management is not as optimistic. They believe that revenue will fall by between 2.5% and 4.5%. This is in spite of a benefit associated with continued acquisitions and acquisitions that were made last year. And this is due to the expectation that organic revenue will contract by around 6%. The midpoint expectation for earnings per share implies profits of $367.6 million, while the midpoint for adjusted earnings per share suggests a reading of $432.5 million. If we assume that other profitability metrics will change at a similar rate as this, then we should anticipate adjusted operating cash flow of about $558.9 million and EBITDA of $800 million.
Using these results, I valued the company as shown in the chart above. Yes, shares do look a bit more expensive on a forward basis. But they are still relatively attractively priced. I wouldn’t call them deep value plays by any means. But they do look undervalued to an extent. I say this not only because of how they are priced on an absolute basis, but also because of how they are priced compared to similar enterprises. In the table below, I compared the more conservative 2024 multiples to the current multiples for five similar enterprises. On a price to earnings basis, only two of the five firms were cheaper than The Timken Company. And when using the other two profitability metrics, only one of the five companies ended up being cheaper.
Company | Price / Earnings | Price / Operating Cash Flow | EV / EBITDA |
The Timken Company | 16.1 | 10.6 | 10.0 |
Parker-Hannifin (PH) | 26.8 | 21.6 | 16.9 |
Dover Corporation (DOV) | 22.5 | 17.8 | 15.7 |
Standex International (SXI) | 14.4 | 19.4 | 10.3 |
Mueller Industries (MLI) | 9.8 | 8.8 | 5.3 |
Watts Water Technologies (WTS) | 25.3 | 21.4 | 16.5 |
In the near term, investors should be paying attention to what new data will come out. If we see some downward revisions that suggest further weakness ahead, my view on the matter could change. But I think we would have to see more pain than what analysts are anticipating. For the first quarter of 2024, analysts believe that revenue will be about $1.15 billion. This would be down from the $1.26 billion generated in the first quarter of 2023. Earnings per share, meanwhile, should come in at around $1.42. That’s a drop from the $1.67 per share reported the same time last year. That would also translate to net profits falling from $122.3 million to $102.4 million. Also, for context, you can see some other profitability metrics shown in the table below, investors would be wise to see how the company stacks up against these figures when new data comes out. But if earnings are expected to fall, it’s likely that these will decrease as well.
The short term does have some bearing on performance. But even if results do show signs of deterioration, investors should continue to pay attention to the long-term outlook as well. The fact of the matter is that management has been making some interesting investments in recent years. For instance, they’ve been focusing on catering to what they call ‘newer markets’. Examples here include renewable energy, automation, industrial services, marine, food and beverage, and passenger rail. Back in 2014, revenue associated with these markets accounted for only 13% of the company’s overall revenue. Today, that number is about 29%, or $1.3 billion. That’s a 15% annualized growth rate over that window of time. Much of this has been by means of acquisition.
Of course, this does not come cheap. The company has had to make some major investments in order to get where it is today. For the Industrial Motion segment, for instance, the company has had to allocate around $2.5 billion toward mergers and acquisitions during this window of time. That has allowed that unit to expand revenue by about 16% per annum, eventually hitting about $1.5 billion in 2023. Continued investments are expected to take revenue even higher to roughly $2 billion or more by 2026. Some of the emphasis will even involve avenues that some investors might be surprised with. Much of the renewable energy market these days appears to be focused on solar power. But this doesn’t mean that wind power is unimportant. From 2013 to 2023, The Timken Company has seen an annualized growth rate in excess of 20% when it involves catering to this market. And what’s really exciting is that, from 2022 through 2027, it’s expected that offshore wind turbine capacity will grow from 7.3MW to 14.5MW while onshore capacity will almost double from 3.8MW to 6.5MW. That suggests further growth in the years to come.
Further growth will continue, and it will almost certainly be in the form of additional acquisitions. In 2023, for instance, the company allocated about $1.1 billion toward various initiatives, with 55% of that involving acquisitions. But this doesn’t mean that management isn’t focused on other things as well. Last year, the company spent $345 million on a combination of share buybacks and dividend payments. In all, it repurchased 3.2 million shares, accounting for over 4% of all outstanding shares at the time, in exchange for $251 million. Since 2013, the company has repurchased over 30 million shares, reducing the total share count by roughly 25%. Management expects to purchase another 2.7 million shares between the end of last year and February 2026 when its 10 million share buyback program expires. It also paid out $94 million in cash dividends, representing the 406th consecutive quarter of a dividend payment. And what’s really impressive is that the company still had enough money left over to allocate $188 million toward capital expenditures to support core operations, while also keeping leverage within the target range of between 1.5 and 2.5. As of the end of last year, it was 2.1.
Takeaway
When you add up everything, the good and the bad, associated with The Timken Company, it’s difficult, at least in my mind, to be bearish or even neutral. The company is not a slam dunk opportunity, and shares are a bit more expensive on a forward basis because of the expectation of weakness this year. But the stock is still attractively priced and management continues to make investments that matter. In the long run, I fully expect that The Timken Company will continue to do well for itself and its investors. And while there may be periods of underperformance, I do believe that the long-term trajectory is positive enough to warrant a ‘buy’ rating.