The Timken Company: A low-cost supplier with temporary problems (NYSE:TKR)

Too many people view investing as a form of gambling. However, for value investors like me, successful investing means investing for the long term. While it would be great if investments produced significant returns right from the start, it often takes time. and patience for opportunities to arise. That is why I am not disappointed with how things have gone when it comes to The Timken Company (NYSE: TKRIn April of this year I wrote an optimistic Article about the company. I argued that it deserved a buy recommendation, not only because of its attractive valuation but also because of its market potential. But since then, the stock has fallen 4.8% while the S&P 500 has risen 1.4%.

Many investors could jump ship at this point. But I am not that kind of investor. Although management recently revised down its fiscal 2024 guidance, the overall picture for the company looks positive. Yes, revenue, earnings, and cash flow are expected to decline year-over-year. But even with that, the stock is attractively valued both in absolute terms and relative to similar companies. Debt had risen somewhat in recent years. But even that picture shows signs of improvement. Add all of this together, and I think it makes a lot of sense to continue rating the company a Buy.

Still a solid chance

For those unfamiliar with the Timken Company, the company can be described simply as a manufacturer of engineered bearings and power transmission products. While that may not sound like a particularly exciting market, especially for those interested in growth, in my previous article I discussed some of the fastest-growing opportunities available to the company. These included the wind energy market, the industrial motion space, certain types of transportation, and more. That’s not to say the company will grow consistently from one year to the next. In fact, this year seems to be something of a slow period for the company.

Since I last wrote about the company earlier this year, two more quarters of data have been released. In the most recent quarter, the company’s revenue was $1.18 billion, down 7.1% from the $1.27 billion reported a year earlier. Management attributed this decline to lower organic sales, primarily due to lower volumes due to lower demand. And unfortunately, this sales weakness was evident in both of the company’s business segments. For example, the Engineered Bearings division saw revenue decline 8.6% from $857.2 million to $783.4 million. Although the company saw weakness in its EMEA (Europe, Middle East, and Africa) business, the biggest drag actually came from China, with revenue plunging 48.3% from $156.5 million to just $80.9 million.

A look at the company’s financial statements and a reading of the most recent investor meeting minutes did not provide any indication as to why we are seeing this weakness. However, management said that the problems have been ongoing for four quarters now and that we are seeing some leveling off. They seem cautiously optimistic about the long-term prospects for this market. However, it is worth noting that the problems here are likely not company-specific. Another source I found that was independent of the company cited China’s slowing economy as a problem for the global wind energy market. And it is true that China’s economy has slowed quite a bit compared to previous years.

In addition to the weakness in Engineered Bearings, the company’s Industrial Motion segment also saw a decline in sales. Sales fell 3.9% year-on-year from $415.1 million to $398.9 million. Unlike the Engineered Bearings segment, the decline in Industrial Motion was largely due to weakness outside of China. The US and the rest of the Americas saw year-on-year declines. The EMEA regions also saw a slight decline.

With revenues falling, it should come as no surprise that profitability is suffering as well. Net income fell from $125.2 million last year to $96.2 million this year. While some of the company’s costs declined with revenue, others did not. In fact, SG&A expenses rose from 14.5% of revenue to 15.6%. At the same time, interest expense rose from $28.3 million to $34.6 million. That’s an increase from 2.2% of revenue to 2.9%. Other profitability metrics followed suit. Adjusted net income fell from $146.1 million to $115.2 million. Operating cash flow fell from $144 million to $124.6 million. And if we factor in changes in working capital, we’d see a decline from $186.5 million to $160.8 million. Finally, the company’s EBITDA fell from $263 million to $230.2 million.

In the chart above, you can see the financial results for the first half of 2024 compared to the first half of the previous year. They show a very similar trend, with revenue, earnings, and cash flows deteriorating from one year to the next. This is clearly a downward trend we are going through. But the good news is that even then, shares still look attractively valued. Management’s most recent guidance called for earnings per share between $5 and $5.20. That’s below the previously expected range of $5.10 to $5.40. But on the midpoint, that would still equate to net income of $361.3 million. On an adjusted basis, earnings per share should be between $6 and $6.20. The high end of that range is $0.10 per share below what was previously expected. On the midpoint, we would expect adjusted net income of around $432.2 million. These numbers are both below what the company experienced in 2023. And this is likely to happen against the backdrop of a sales decline of between 3% and 4%.

Of course, there are other profitability metrics to look at, but we don’t have management estimates for what those will look like. Annualizing 2024 results to date would give us adjusted operating cash flow of about $530.4 million and EBITDA of $847.4 million. Using those numbers, as well as historical numbers from 2023, I was able to value the company as shown in the chart above. Even though the stock is more expensive on a forward basis, I would still say it’s in the value range, albeit by a small margin. In the table below, I compare The Timken Company to five similar companies. On a price-to-earnings basis, it’s currently the cheapest of the bunch. But in terms of profitability metrics, (Mueller Industries) MLI is slightly cheaper.

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Another point to look at is debt and the impact it has on the company. From 2021 to 2023, the company’s net debt increased from $1.21 billion to $1.98 billion. Fortunately, we saw a slight decrease to $1.71 billion in the last quarter. So, the picture is definitely improving. The chart below shows the company’s net debt and net leverage ratio, with EBITDA for 2024 based on my forecast used in valuing the company. From 2021 to 2023, there was an increase in total debt. But fortunately, this picture has also been improving recently. In the same chart, you can also see the company’s debt ratio. This shows a similar trend, but with a peak in 2022. And since then, it has been in a state of decline. That is also encouraging to see, especially considering how high interest rates are right now.

Bring away

I’ve long liked the Timken Company. The company has a long operating history, and I grew up very close to its world headquarters. I always saw it when my family and I passed by. But it’s not that emotional bias that makes me bullish on the company. It’s true that recent financial performance has been discouraging — but despite that pain, shares appear to be attractively valued. Debt had been rising in previous years, but the recent decline on that front gives investors another reason to be optimistic. Add all of this together, and I still think the Timken Company deserves the buy rating I previously gave it.