Familiar Challenges Show Up For Manitowoc Too

By Stephen D. Simpson, CFA | November 07, 2012 AAA

Investors who have been following developments in the construction equipment and foodservice industries probably weren't too surprised with Manitowoc's (NYSE:MTW) third quarter, even if results were lower than the sell-side analyst averages. Order trends still point to an ongoing recovery in the crane business, and the food equipment business is still solid, but 2013 could be challenging on both sides. Manitowoc's shares do look undervalued today, but investors considering the shares cannot afford to ignore the above-average risks here, nor the extent to which share performance will be tied to macroeconomic developments.

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Weak Results Drive a Sizable Q3 Miss
Given the performance at companies like Terex (NYSE:TEX), Caterpillar (NYSE:CAT) and Sany (OTC:SNYYF), there weren't a lot of reasons for much optimism this quarter, and Manitowoc did in fact miss estimates. That said, Manitowoc is continuing to grow through some tough overall market conditions.

Revenue rose about 2% this quarter, with the total result missing the average analyst estimate by about 5%. Revenue from cranes was up about 5%, but missed expectations by a wide margin due at least in part to over $100 million in delayed orders/shipments tied to some component issues. Foodservice revenue was down about 1% for the quarter.

Although gross margin improved more than a point, operating profit improved by about 1% on an adjusted basis. Foodservice segment income improved about 7%, due largely to better mix. The crane business saw slightly less than 2% growth in segment earnings, due to a host of issues including lower Chinese sales, customer finance reserves, and costs tied to expansion in Brazil - take those out and the crane segment's earnings would have been up more than 30%.

SEE: How To Decode A Company's Earnings Reports

Is Crane Optimism Still Well-Founded?
Manitowoc's crane business has been seeing a slow, but real recovery, even as emerging market demand has stalled out in 2012. I do worry, though, that 2013 expectations could be too high at this point. Admittedly, Manitowoc's exposure to residential construction is lower than the industry average, but energy market demand could be past the peak and the potential fallout from the government's sequestration (the "fiscal cliff") could hit the industrial business. Along these lines, and like General Electric (NYSE:GE) a short time ago, Manitowoc management pointed out that the end of certain tax benefits to wind power will slow that market considerably next year.

Can Foodservice Demand Overcome Weaker Traffic?
Relative to companies like Dover (NYSE:DOV) and Illinois Tool Works (NYSE:ITW), Manitowoc's foodservice performance wasn't bad, though we'll have to wait for Middleby's (Nasdaq:MIDD) earnings (after the close Tuesday) to see how market share is stacking up.

Whether Middleby continues to gain share or not, I'm likewise a little concerned about the 2013 environment for foodservice equipment. Sysco (NYSE:SYY) just reported weaker case volume growth and indicated that traffic continued to weaken into October. Likewise, companies like McDonald's (NYSE:MCD), Brinker (NYSE:EAT) and Chipotle (NYSE:CMG) have all been getting more conservative with their traffic growth outlooks for the fourth quarter and the first half of 2013.

SEE: Can Earnings Guidance Accurately Predict The Future?

Business Likely to Get Better, but How Much Better?
Manitowoc bulls can fairly argue that there's still a ways to go with this recovery in the crane market, and that the 22% year-on-year growth in crane orders shouldn't be dismissed lightly. Along similar lines, I don't dispute the thesis that there is plenty of room for emerging market growth, not to mention infrastructure spending and commercial construction in North America.

That said, Manitowoc has both high debt and low consistency with free cash flow generation. The free cash flow margin generally bounces around from the very low single digits into the mid-7%'s, and most sell-side analysts are already predicting that the company will continue to deliver at the high end of that range on a consistent basis. In other words, a lot of improvement would already seem to be factored into today's valuation.

SEE: Free Cash Flow: Free, But Not Always Easy

The Bottom Line
I'd be curious to know how many investors view Manitowoc as a great crane company with a dependable foodservice business that produces good margins and free cash flow attached, as opposed to a very good foodservice business devalued by a deeply cyclical and volatile crane business. How you see that question probably speaks to whether you're optimistic that an ongoing recovery in cranes will propel the shares higher, or whether you think the potential for a weak global economy in 2013 will put the stock's multiple at further risk.

Whichever the case, I'm cautious about this stock today. Even with mid-to-high single-digit revenue growth, Manitowoc is going to have to show a higher (and more consistent) level of free cash flow generation than it ever has before to drive a substantially higher fair value. Pragmatically, I think Manitowoc is a good play for investors who are bullish about the global economy in 2013, but those considering a long-term commitment should make sure they're comfortable with the company's debt load and inconsistent free cash flow generation.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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