The Timken Company: Flexing Its Muscles (NYSE:TKR)

Aug 09, 2023

skynesher

Shares of The Timken Company (TKR) have recently come to life again as investors had some doubts on the impact of slower growth on the business in 2022. It has been a long time since I last looked at Timken, in fact it was 2017 when the company announced a sizeable bolt-on deal in the Netherlands, marking the end of a multi-year restructuring story which included the 2014 spinoff of Timken Steel.

Back in 2017, Timken was a $2.7 billion producer of bearings, power transmission products, and related services, being the leader in tapered roller bearings. These differentiated products gave the company an interesting positioning, that is after the company was struggling amidst leverage, pension liabilities and previous exposure to volatile steel operations.

Bearings are typically used in automotive, industrial, rail, energy, truck, defense and agricultural markets. With a $2.7 billion revenue number reported in 2016, net profits came in at $153 million, equal to $1.92 per share, roughly equal to the reported adjusted earnings. An EBITDA number of $325 million supported net debt of $507 million, working down to a 1.5 times leverage ratio, although this ratio rose to 2.3 times once pension liabilities were taken into account.

With shares trading around the $40 mark, the situation looked quite fair at a 20 times earnings multiple, as the company announced two deals including a $280 million deal for GroeneveldGroep, adding about $100 million in sales and about $20 million in EBITDA. Pro forma leverage was set to rise to 2.6 times, based on just over a billion dollars in net debt and $400 million in EBITDA, as the market-equivalent multiple and troubled past did not create an automatic situation to buy the shares.

Trading near the $60 mark ahead of the pandemic, The Timken Company shares fell in an initial response, only to see a fierce rally to the $90 mark in spring of 2021, when markets at large were rallying. What followed was a slump to the $50s last summer, amidst concerns on growth, a strong dollar and inflationary pressures, among others. After a tough set-up by mid-2022 a huge rally followed, taking the shares to $84 at the moment of writing.

Shares of Timken still traded around the $60 mark early last year when the company posted its 2021 results, a year in which revenues rose nearly 18% to $4.1 billion, indicating that sales had risen some 50% from 2017 onwards. Adjusted earnings, which looked quite clean, came in at $363 million, equal to $4.72 per share as earnings per share growth had outpaced sales growth with EBITDA reported at $700 million. Leverage ratios had come down to 1.7 times as the company has come a long way, albeit that 2021 was a strong year.

Ahead of a more turbulent 2022, the company guided for 10% sales growth that year, with earnings growth seen in line with the topline sales trends, as the midpoint of the adjusted earnings guidance was set at $5.20 per share. All this created quite a compelling situation at $60. The 76 million shares outstanding represented a $4.6 billion equity valuation, or $5.8 billion enterprise valuation based on about $1.2 billion in net debt.

In April, the company announced the purchase of Spinea, adding $40 million in robotic application related sales, with the deal taking place at an unknown price tag. First quarter results were quite strong, yet the company maintained the guidance. After posting another double digit increase in second quarter sales, accompanied by good profitability, the company actually hiked the midpoint of the earnings guidance to $5.65 per share.

The operating performance actually strengthened management´s confidence into pursuing a deal to acquire GGB Bearing Technology, a $200 million business from Enpro Industries in September. In October, the company posted another decent set of third quarter results, with sales up another 10% and earnings now seen between $5.80 and $5.95 per share. Right now sales are set to surpass $4.5 billion, as increased capital allocation made that net debt has risen to $1.5 billion, albeit that adjusted EBITDA might come in close to $900 million this year, keeping leverage ratios in check.

In January, Timken announced its next deal, this time acquiring European-based Nadella Group, a produce of industrial motion solutions in a deal set to add EUR 100 million in sales. A few days later, Timken announced the acquisition of American Roller Bearing company, a deal set to add $30 million in sales.

Given the operating momentum and bolt-on dealmaking, I expect to see a run rate of earnings around $6 per share here, while leverage remains firmly in check at around 2 times EBITDA (or just below that). This makes that valuations looked reasonable at $70 in December, at 11-12 times earnings. Shares now trade at 14 times earnings after a big rally in January, which still looks reasonable, albeit that the cyclical earnings look strong.

The truth is that I am very appreciative of the strong growth and turnaround of The Timken Company in recent years, notably in 2021 and 2022. Hence, Timken looks well-positioned and trades at reasonable multiples, perhaps in a fear of the cycle turning, as shares have done quite well.

Given all this, I am very appreciative of The Timken Company here, although I fear to buy the shares after a rip higher, making me constructive on the shares, albeit that I am waiting for a pullback before considering an allocation here.

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