jetcityimage
It has been a decade since I last looked at Regal Rexnord (NYSE:RRX) which at the time was still known as Regal-Beloit. The company acquired the power transmission business of Emerson Electric (EMR) in a $1.44 billion deal.
In the years which followed, it was the operating performance which has been largely stagnant, as M&A activity last year changed the investment thesis at an uncertain point in time, making me cautious to buy the current dip.
A Quick Trip Down Memory Lane
The purchase of the transmission business of Emerson, as announced late in 2014, was set to grow all of Regal-Beloit in a deal set to add 20% to sales. Pro forma of the deal, Regal-Beloit was set to become a near $3.8 billion business.
With pro forma net debt seen at $1.8 billion, leverage ratios were seen at around 3.6 times EBITDA. Based on 45 million shares trading at $72 per share, equity was valued at around $3.2 billion, with the company commanding an 14-15 times earnings multiple at the time. Synergies and the earnings contribution had the potential to lower forward earnings multiples to about 12-13 times earnings, which looked quite compelling.
Such an earnings multiple look quite attractive, also given the business positioning, as leverage ratios in the mid-3s were a bit too high for my comfort.
Stagnant – And On Fire
Since 2014, shares of Regal Rexnord have been trading largely range bound between $70 and $90 until the start of the pandemic. Post pandemic, shares had risen to a high around $170 per share in 2021 and ever since shares have traded in a $110-$160 range. By now shares are trading towards the lower end of the range at $122 per share.
In October of last year, shares traded in their $130s when Regal announced the acquisition of Altra Industrial Motion in a huge $4.95 billion deal, after rumors about a combination of both firms have been swirling around in recent years already.
In February of this year, Regal posted its results for 2022, being the last full year earnings release as a standalone business. Revenues rose 37% to $5.22 billion on which operating income was reported at $690 million. GAAP earnings of $489 million came in at $7.29 per share.
Adjusted earnings were reported at $10.75 per share, with most of the discrepancy being the result of a more than $2 per share amortization charge, as well as numerous other charges. Net debt was reported at $1.33 billion, perfectly manageable with EBITDA reported at $1.11 billion that year, for a leverage ratio of just over 1 times.
2023 So Far
The company closed the purchase of Altra during the first quarter, although that was not seen in the results with first quarter sales down 6% to $1.22 billion. This came as the deal only closed on the 27th of March, thereby not making a real impact on the quarterly results.
The cash deal for Altra made that net debt was reported at $6.1 billion alongside the first quarter earnings report. In that light, it was it comforting to see a modest increase to the full year adjusted earnings per share guidance. These earnings were now seen at $10.20-$11.10 per share, at the midpoint up 20 cents compared to the year before.
Second quarter sales rose some 31% to $1.77 billion, but operating earnings fell 23% to $152 million, while quarterly interest expenses ballooned to $116 million. GAAP earnings were badly impacted by amortization charges, but even adjusted for these, adjusted earnings did fall twenty cents to $2.56 per share. Troublesome was that the full year guidance was implicitly cut, with earnings now seen between $10.20 and $10.60 per share.
Net debt ticked down to $6.0 billion. With quarterly adjusted EBITDA of $380 million working down to an annualised 4 times leverage ratio, it was clear that leverage was on the higher side.
Based on the second quarter earnings report, we can see the impact of the deal in the business mix. The industrial powertrain solutions business grew by two-thirds to 40% of sales following the Altra acquisition. Automation & motion control more than doubled as well, now making up over a quarter of sales. The industrial sales systems business posted flattish revenues, making up 10% of sales. The real headwind came from a 20% fall in power efficiency solutions, making up about a quarter of sales.
With 66 million shares trading at $122 per share, the company commands an $8 billion equity valuation, and about $14 billion enterprise valuation. This was equal to about 2 times annualised sales, nearly 10 times EBITDA and shares trade at around 12 times adjusted earnings.
A Small Sale
In September, Regal Rexnord announced the sale of the Industrial Motors and Generators business in a $400 million deal.
The deal will make a small positive impact in reducing leverage, but no other financial details other than the purchase price have been announced.
Concluding Remarks
In a sense, we are back to a similar situation as 2014. Just like nearly a decade ago, leverage ratios are sky-high following a substantial deal, as the pro forma earnings multiples are non-demanding in the low-teens.
In that sense, the situation looks reasonably comparable and compelling, more so as the shares have been trading really sluggish for a few years now. Given this, I am quite upbeat on Regal. At the same time, I am aware that leverage is higher now, operating momentum has cooled down quite a bit, and a mega deal was paid for with cash (read debt) in a rapidly-rising interest rate environment.
Given all this, I am mindful of the risks here, and I am taking a wait-and-see approach, requiring stabilization in end markets and some real achievements in terms of lower leverage before potentially contemplating taking a position.
