Matthews International Q2: Warehouse Automation Muting Energy Growth (NASDAQ:MATW)

Matthews International Corporation (NASDAQ:MATW) just reported fiscal Q2 results. We are seeing quite major impacts from warehouse automation, but as mentioned in our last quarterly coverage, MATW is still on track to see some incremental improvement into the next quarters. Energy is doing fine within industrial tech, but the major order that came in early 2023 is still only half resolved, and has been that way now for a few quarters as EV plans get pushed out by major OEMs. Memorialization is alright, it should have a good performance as we move further away from tougher COVID-19 comps, and SGK is way more efficient now and less of a burden.

Beyond this year, we expect that the energy solutions business should eventually see major order realization, and other strategic initiatives in this business should hopefully address long timelines in the future. We also think that the energy business profile should start improving, as detailed in our previous coverage focused on the Borger acquisitions. A big catalyst for MATW is a recovery in P/E and other sponsor activity. It is taking time, but will inevitably happen when the cost of capital decreases. We still believe in the upside for Matthews International Corporation.

Q2 Earnings

Let’s blast through Q2 earnings.

Memorialization has a volume issue due to lower death rates YoY due to COVID-19. There is no fundamental demographic problem in MATW markets. Furthermore, they have won a new account – possibly the UK account they mentioned last quarter. About 15-20% of MATW is exposed to cremation equipment sales. Those should be growing, but the volumes of deaths overall are being a problem, and the only reason sales performance isn’t worse is because of the addition of Eagle Granite in February 2023.

This is a comp volume problem, and lapping COVID-19 will solve it. Underlying trends are good, and the incremental margin performance is improving as pretty long-held inventory starts to see declining commodity prices factor in also under a higher pricing regime than before. This remains an attractive, cash cow business.

Industrial technologies is suffering due to warehouse automation, which could be down as much as 30%.

If you look into the automated warehouse marketplace, you’ll see our competitors who are much more public about it, struggling as well. I mean these numbers could be off 20%, 30% on the top line. We’re consistent with that. But we think that turns.

Joe Bartolacci, CEO of MATW, Q2 Call.

Apparently, quoting activity is seeing improvement here, which is good. But weaker margins on engineering, and generally falling margins on engagements as they go from planning to implementation where planning is a higher margin activity, has taken a major toll. Moreover, software sales are probably down, which is another negative mix effect.

On the other hand, the energy segment, which sells calendaring equipment for dry filming, is looking quite good. The major orders from last year, likely coming in from a major battery OEM that supplies one of the auto majors in the U.S., we speculate possibly Ford (F) or General Motors (GM) which are both building out EV factories in the U.S., are still not fully liquidated. They have been half-liquidated now for a few quarters. Eventually, these will come through to provide a major boost to the segment, but things are being pushed back on the well documented issues in EV demand. They also have an emerging hydrogen fuel cell business here.

SGK sales are doing OK, led by the U.S. with Europe still being quite challenged. Comps are not tough, so the revenue performance is nothing to write home about. But the performance in margins is impressive and is the result of a pretty aggressive cost control and restructuring plan for the business. It seems this business has bottomed out for now.

Bottom Line

We are slightly worried about debt.

There is a big maturity wall in 2025, although this is for a revolving credit facility that is already variable rate. Terms shouldn’t get much worse. The issue might be the 2025 senior notes. These could get refinanced at higher rates in 2025 assuming the current prevailing rate picture persists. The leverage ratio is at 3.6x, so that’s going to hurt quite a bit. We think this could cause a 20-25% increase in interest expense, or around $10 million. It would take away around 25% of 2023 FY income.

Besides that, we are also somewhat concerned with the orders from the battery OEMs. There needs to be enough confidence in EV demand for the market opportunity here to be fully realized. The other segments don’t concern us that much, although SGK is also more cyclical. We think warehouse automation should bottom out this quarter, although margin lift will be slow since it’s in a less profitable phase of the contract performance cycle.

We are optimistic about operational improvements at Olbrich and R+S as they restructure those businesses. Not only that, but we think memorialization is going to improve. In addition, we are also expecting the energy solutions deliveries to come through and provide a big revenue lift from the battery OEM customers. We are also excited about the new printhead solution slated for commercialization in January 2025. This could be a significant market if the price performance characteristics of this new product are as good as promised.

We value Matthews International Corporation stock on a sum of the parts basis based on casket maker multiples, average industrial multiples and then a punitive multiple for SGK, which is the least interesting business from a P/E point of view. Better sponsor markets are an important factor for this upside to ever materialize. Sponsor markets are still exceptionally weak.