Mayville Engineering: As Mr. Market Becomes More Bearish, I Become More Bullish (MEC)

When it comes to investing, patience is a double-edged sword. On the one hand, waiting long enough for an investment thesis to play out is often necessary. On the other hand, if you wait too long, even if things turn out the right way, the annualized return that you achieve might be less than ideal. One company that investors likely feel frustrated about is Mayville Engineering Company (NYSE:MEC). After all, since I last rated the business a ‘buy’ back in February 2023, shares have seen a downside of 10.2%. That compares to the 22% increase seen by the S&P 500 over the same window of time.

Many investors in the company may have given up by now. However, I believe that would be premature. In the short term, yes, there has been pain. Financial performance has not been perfect, but it hasn’t been awful either. What’s more, management is forecasting continued growth this year and for the next two years after. The company operates in a rather sizable market that management pegs as being worth $50 billion and, if the firm can achieve targets set by management, upside potential should be significant. Given these factors and how cheap the stock is, both on an absolute basis and relative to similar enterprises, I would argue that further patience is likely to be rewarded rather handsomely. In fact, I am so confident that I have decided to upgrade the stock from a ‘buy’ to a ‘strong buy’.

It is important to keep in mind, however, that the picture could always change based on new data that becomes available. It just so happens that the next opportunity for that should be on May 7th after the market closes. At that time, management is due to report financial results covering the first quarter of the company’s 2024 fiscal year. But the good news for my thesis is that analysts are forecasting continued improvement year-over-year. So long as we don’t have any surprises on the downside, I don’t see my new stance on the firm changing.

Give Mayville Engineering Company time

Given the return disparity achieved between Mayville Engineering Company and the broader market, you might think that the company was facing some pain. But that wouldn’t be the case. Fundamentally speaking, things have been going quite well as of late. The business, which focuses on providing manufacturing solutions involving production, design, prototyping, tooling, fabrication, coating, and more, has seen continued growth on the top line. Revenue in 2023, for instance, came in at $588.4 million. That’s an increase of 9.1% compared to the $539.4 million generated in 2022. According to management, this growth was driven by a combination of factors, namely its acquisition of MSA (Mid-States Aluminum) in exchange for $90 million on a net basis. However, the company did benefit by an unspecified amount from higher organic sales volumes associated with commercial vehicles, power sports, and military end markets. The company also cited ‘continued price discipline’ as a contributor to increased sales. Though I would argue that this could only mean increased prices on products since it was cited as having a positive impact on revenue.

On the bottom line, the picture was a bit more complicated. Net profits for the company actually fell from $18.7 million in 2022 to $7.8 million last year. This was in spite of manufacturing margins growing from 11.3% of sales to 11.8%. The biggest contributor to the downside was a rise in interest expense from $3.4 million to $11.1 million. This was because of higher debt levels that the company had to accept in order to acquire MSA, combined with a rise in interest rates. Other profitability metrics have been volatile. Operating cash flow, for instance, went from $52.4 million to $40.8 million. Even if we adjust for changes in working capital, we would get a decline from $47.9 million to $34.4 million. On the other hand, EBITDA for the company managed to rise from $60.8 million to $66.1 million.

If we use the historical data from 2022 and 2023, we can see, in the chart above, just how cheap shares are today. Yes, the stock does look more expensive on a forward basis when it comes to the price to adjusted operating cash flow multiple. But to see a firm that’s trading in the mid to high single digits is still quite impressive. In the table below, meanwhile, I compared it to five similar firms. Using the price to operating cash flow approach, I found that Mayville Engineering Company was the cheapest of the group. And when it comes to the EV to EBITDA approach, I found that only one of the five companies ended up being cheaper than it.

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Despite the mixed results achieved in the near term, shares look cheap, and the company looks fairly healthy. However, what really got me to increase my rating on the company was the outlook provided by management for the next few years. Leveraging its extensive vertically integrated network that includes 23 facilities located in the continental US, as well as a variety of other resources, the company is forecasting revenue growth for the next few years. This year, for instance, management believes that revenue will be between $620 million and $640 million. However, they also believe that organic revenue growth will be between 10% and 15% per annum between now and 2026. That would take sales up to between $750 million and $850 million by then.

Along the way, profit margins are expected to grow nicely. For instance, EBITDA is expected to grow from between $72 million and $76 million this year to between $105 million and $135 million in 2026. Free cash flow is also expected to grow nicely. However, I am less concerned about that and more concerned about adjusted operating cash flow. Based on my own estimate, it should come in at around $57.5 million this year. And by the end of the forecast period, it should grow to between $80 million and $95 million, for a midpoint of $87.5 million. Even though I mentioned organic growth, about $40 million to $50 million of this involves the aforementioned purchase of MSA. Pricing improvements are expected to add another $25 million to $45 million to the company’s top line, though it will see a hit of between $15 million and $20 million involving product offerings that are going to be coming offline.

The same pricing improvements are expected to help from a margin perspective. But they won’t account for all of the improvement. For instance, the company is going to be looking at ways to improve supply chain productivity and maximizing labor productivity in order to get where it needs to be. Better plant utilization is expected to add between 1% and 1.5% to the company’s margins as well. On the other hand, wage inflation is going to be pushing down on some of this, likely to the tune of between 1.5% and 1.6% on a margin basis.

In the event that management can achieve their targets, shares look very attractive. Using 2024 estimates, the company is trading at a price to adjusted operating cash flow multiple of 5.8 and at an EV to EBITDA multiple of 5.8. By 2026, these multiples will be 3.2 and 3.6, respectively. If we assume that the company should eventually trade at the same multiples that it is expected to trade for this year, then achieving those targets for 2026 would translate to annualized upside of between 35.3% and 45.2%. Even if the company comes in at half that, it’s still an impressive showing.

Along the way, management does have other plans. At the end of last year, net debt translated to a net leverage ratio of 2.1. By the end of this year, that’s expected to fall to between 1.5 and 2. The company is also looking at buying back additional stock. Last year, management bought back only $2 million worth of shares. However, they are interested in buying back up to $25 million by the end of 2026. I’m not normally a fan of share buybacks. But when shares are this cheap, it just makes sense.

As I mentioned already, management is due to report financial results covering the first quarter of the 2024 fiscal year after the market closes on May 7th. At present, analysts are forecasting sales of $160.2 million. That would be well above the $142.6 million the company reported one year earlier. Earnings per share, meanwhile, are forecasted to grow from $0.12 to $0.15, taking net income from $2.6 million to $3.3 million. We don’t know what other metrics will look like, but in all likelihood, if analysts are correct, the important ones shown below will also rise nicely year-over-year.

Takeaway

As things stand, Mayville Engineering Company strikes me as a really attractive opportunity. Management has a plan, and they seem to be delivering on it. Things aren’t perfect, but you can’t expect for them to be. The stock is attractively priced, both on an absolute basis and relative to similar firms. And when you factor in projected growth for the next couple of years, it’s difficult to be anything other than bullish. Because of that, I’ve decided to upgrade the company from a ‘buy’ to a ‘strong buy’.