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An annuity with a growth option on top of an attractive balance sheet – this is the essence of an investment in Albany International today.
On 8/4/15, Albany reported its Q2 results, missing consensus estimates on account of a dramatic slowdown in a portion of its Machine Clothing segment. A week later, Albany’s primary competitor in this segment, Xerium Technologies, reported similarly disappointing numbers and gave an aggressively bearish outlook for the remainder of the year. These events, coupled with recent market volatility, have provided investors an attractive entry point into a unique little company with characteristics that should appeal to value and growth investors alike.
Albany International operates two business segments: Machine Clothing and Engineered Composites.
Machine Clothing (MC) – (The "annuity")
AIN’s machine clothing business supplies consumable fabrics and belts used in the production of paper, paperboard, pulp, and corrugator products. AIN’s primary customers in this business are International Paper, Rock-Tenn, Georgia Pacific, and P&G. AIN is the worldwide market leader in this segment with market share of approximately 30%. Its closest competitor, Xerium, has approximately 15% share. The rest of the market consists of smaller, private companies.
While writing/printing grades of paper end markets are in secular decline, particularly in North America, paperboard/corrugators (think tissue, food/beverage packaging, etc.) will grow with global GDP over time. Albany overindexes to the “growth” grades of paper end markets, and for this reason management has pitched the MC business as a flat EBITDA business over time. This is a stable, free cash flow machine that management has been using to fund the growth at Albany’s smaller, more sexy, business.
Albany Engineered Composites (AEC) – (The "growth option")
AIN also leverages its historical textiles and materials processing capabilities and applies this technology to products in the aerospace and defense industries, where it currently provides highly engineered, advanced composite structures. AIN has found success here as the sole source supplier of advanced composite fan blades and cases for CFM International’s LEAP engine, which is scheduled to enter into service in 2016 and has already become the best-selling engine under development in history. The demand for such engine components is strong, as AIN’s composites have proved to be both stronger and lighter than traditionally used metal pieces, making aircraft both safer and far more fuel efficient.
With current industry production estimates of 1,900 LEAP engines per year by 2020, and with ~$100k in revenue for AIN per engine, investors can expect AIN’s revenue in this business to more than quadruple over this time period. Such growth gives no effect to any potential additional programs AIN might win on the LEAP engine or other parts of the aircraft.
The JV with Safran –
The LEAP engine is manufactured by CFM International, a joint venture between GE and Safran. In an effort to secure access to AIN’s critical fan blades/cases, Safran invested $28m for 10% of AIN’s Composites business related to any LEAP products.
While the Composites business is too small to stand on its own today, once it ramps production investors will begin to think about a separation of these two companies, which serve entirely unrelated end markets.
Q2 aftermath –
Despite alarming and unexpected softness in the printing/writing grades of paper in North America during Q2, AIN’s H1 2015 EBITDA is up 1.5% y/y, and AIN’s full year guide going into Q2 was for flat EBITDA in MC. In other words, despite a really bad Q2, AIN is still tracking ahead of guidance.
SOTP is pretty straightforward here.
Safran’s investment in the Composites business effectively set a floor for valuation of this segment. $28m for 10% implies a value of $252m for AIN’s 90% stake. At AIN’s current price, this implies a multiple of 6.0x and an unlevered FCF yield of >10% for MC, assuming management hits its MC guidance of flat EBITDA in 2015. Xerium currently trades at 7.4x, has lower margins, and is more exposed to the paper end markets in secular decline.
AIN’s non-LEAP revenue in the Composites business is roughly ~$45m, marginally profitable at the EBIT level, and stable (but not growing). I value this at 0.50x revenue.
Putting it all together:
At XRM’s current multiple, MC is worth $27.60/share (100% of the AIN’s minimal net debt applied to MC here).
At $280m for AEC, AIN’s 90% stake is worth $7.85/share.
At 0.50x revenue, non-LEAP AEC is worth $0.70/share.
Total - ~$36/share or ~25% upside from current levels. I view this as something of a downside scenario, as AIN’s MC business should trade at a premium to XRM, and sentiment around the LEAP engine is much more bullish now than when Safran made its investment in AIN in 2013. Note AIN also pays a dividend (2.3% yield).
There is further upside around potential applications of AIN’s composites technology to the automotive end markets. Imagine a side beam on a car that weighs a fraction of what’s used today and that is more resistant to impact. AIN has begun exploring applications with high-end auto manufacturers, but this is very speculative now and I would not pay much for optionality around this initiative.
Why does this opportunity exist?
AIN is not well covered (only 3 analysts cover the stock and none from a BB bank) and the stock is fairly illiquid. Many investors likely don’t know what to make of the company given its discrete end markets, and some would certainly like exposure to one of the two businesses but not the other.
Dual Class –
AIN is a dual class stock, which may turn off some investors. The Standish family controls 57% of the vote but only 18% of the economics. My understanding is that the Standish family is not directly involved in business operations. The family has two representatives on the board, and their relationship with management is good. There is zero evidence to suggest the family has ever done anything to obstruct value creation and to my knowledge there has never been a disagreement between the family and management or other members of the board.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise do not hold a material investment in the issuer's securities.