The shares of Manitowoc (MTW:NYSE) are up 20% year-to-date and could have some interest for investors. Manitowoc’s crane business is a great way to play a rebound in non-residential construction over the next 12-18 months. While the non-residential market has remained relatively stagnant, certain leading indicators have started to show some signs of life. Some analysts are forecasting a recovery in non-res activity in 2014 which would likely generate significant order activity and upside to current earnings forecasts. Even if the recovery is pushed out a bit further, and order growth in 2014 is mild, the cost cutting measures over recent years should positively impact incremental margins. In particular, if Europe shows signs of life, the upside could be more significant than expected (like we discussed Caterpillar and China).
Manitowoc is a manufacturer of cranes and food service equipment. The company did close to $4 billion in sales in 2012 with about 60% coming from Crane and 40% from Foodservice. The Foodservice business is relatively stable, with around 65% of demand related to replacement. Annual changes in end market demand in food equipment levels tend to move in the low to mid-single digits. Crane is the opposite; it is deeply cyclical with peak to trough volume changes of 50%+ depending on the type of equipment. The Foodservice business provides Manitowoc with earnings stability and cash flow throughout the cycle but the stock tends to move along with changes in the Crane business.
Crane Orders/Backlog Drive Stock
The stock price moves most closely with the crane business. The backlog is the key driver here along with book-to-bill ratio. The book-to-bill ratio is simply orders/sales. A ratio over one indicates an increase in the backlog and that sales should grow. If it is under one, the backlog declines and sales may follow. There is some degree of seasonality and special events that impact book-to-bill to monitor.
Non-res construction drives crane orders. The forecasts for 2014 are for improvement in non-res construction following growth of about 2% in 2013. The consensus forecast is currently for about 8% growth in non-res during 2014. Importantly the Dodge Momentum Index, an indicator of non-res demand, improved again in September as it has much of 2012. This index tends to lead actual spending by about twelve months. Improvements in crane should all lead to at least a moderate increase in crane orders.
Crane Margin Expansion, Europe could Lead to a Beat
Earnings growth will also be driven by margin expansion in the Crane Segment. Analysts closely watch incremental/decremental margins both sequentially, meaning quarter-over-quarter, and year-over-year. Incremental margin is the additional dollar of profit earned on the increase in year-over-year sales. Important factors that drive incremental margins are increased fixed cost absorption, economies of scale, sales mix (higher margin products contribution to sales), and ability to get pricing beyond just cost increases.
Manitowoc has focused on cutting fixed costs, improving its supply chain and a more lean manufacturing process. The Street may have not fully accounted for margin upside when volume does return to more normalized levels. In particular in Europe, where the company is not earning money and lost it in some recent years, a mild rebound in sales could have a greater than expected impact on earnings. Along these lines, Potain – its tower crane operation – and plants located in Europe had employment restrictions for many years following their acquisition over ten years ago. During the downturn, management was able to cut labor and improve costs structure. Labor made concessions to keep plants from closing or moving permanently. This increased efficiently and margins at many of these plants for the long-term but the benefits have not been seen due to weak demand from the European market.
In addition to benefits from more efficient operations, the loss carry forwards of past years will keep Manitowoc from paying taxes on most European earnings so a majority of the operating profit will flow through to EPS.
Repayment of Debt Generating Value for Shareholders
An acquisition in Foodservice, Enodis, during 2007 increased the company’s debt level which caused problems during the downturn. It has repaid about $150 million ($1.12/share) over the TTM and did similar levels in 2011. It can maintain annual debt repayment level in this range but could significantly accelerate repayment if Crane rebounds. During an upcycle in Crane, the firm could generate in excess of a $1 billion in FCF. With outstanding debt of $1.8 billion, that would result in the transfer of about $9 per share of value to equity holders. In addition, deleveraging reduces the risk level and should lead to increased valuation multiples.
At this point which is early in the crane cycle, MTW should trade in the range of 10-12x EBITDA. Based on 2013 EBITDA estimates, this indicates a range of $20 – $27 based on 2013 estimates and $30 – $37 based on 2014 forecasts.
The risks for Manitowoc are that orders do not bounce back with non-res activity. There are idle cranes in the market that need absorbed before new orders come, this could take longer than expected. In addition, margins could remain compressed due to competition particularly from Chinese brands fighting for share around the world. While this dynamic will play a role, it will do so to a greater extent in emerging markets.
Other related stocks to look at are Terex (TEX:NYSE), Sany (60031:SHA) or a construction equipment firm like Caterpillar (CAT:NYSE). However, Terex and these other firms have much broader exposure to construction equipment and some unique issues. Caterpillar is dealing with weakness in mining while Terex is dealing with issues from an acquisition it made.
Manitowoc is a good way to play a rebound in non-res construction activity. When activity does return, it will likely act as a catalyst for the shares and drive them to a valuation in range of 10 – 12x EBITDA as the Street starts to believe a recovery is underway. Earning could bounce back to a greater degree than expected behind outperformance from Europe of all places resulting from the costs cuts.
What are your thoughts on Manitowoc and the resurgence of non-residential construction?