COLFAX CORP CFX
February 28, 2013 - 2:18pm EST by
varna10
2013 2014
Price: 42.79 EPS $0.00 $0.00
Shares Out. (in M): 94 P/E 0.0x 0.0x
Market Cap (in M): 4,096 P/FCF 0.0x 0.0x
Net Debt (in M): 0 EBIT 0 0
TEV: 0 TEV/EBIT 0.0x 0.0x

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  • Industrial
  • Manufacturer
  • Rollup
 

Description

Summary Thesis: Colfax Corporation (Colfax or CFX) is a diversified industrial companies with a strong and sustainable market positioning operating in high growth end markets and regions. It is pursuing the successful business model pioneered by the likes of Danaher and Roper whereby the management is focusing on building, both organically and through acquisitions, a portfolio of highly differentiated products with superior brands and technologies targeting large high growth markets in which performance and quality matter. Through continuous investment in developing internal talent and relentlessly focused on streamlining operations and improving efficiency, the company plans to generate very high EPS growth 25-30% CAGR over the next 3+ years.  The guidance seems achievable and it is predicated mainly on cost savings via the integration of the recent transformational Charter acquisition.  The multiples are in line with comparable companies, despite the higher growth.  Overall we believe this company can generate 20-25% CAGR of total investment returns over the next 2-3 years and it is therefore recommended for purchase.

Company Description:

Colfax was formed in 1995 and has completed a number of acquisitions and divestitures to strategically focus the business. The most recent transaction of Charter International (January 2012) roughly quadrupled the company’s revenue base and is consistent with Colfax’s plan to become a large, diversified industrial company. Colfax has two reportable segments:

  • Fabrication Technology (51% of 2012 revenue) includes the ESAB business. It designs, manufactures, and supplies consumable products and equipment (including electrodes and wires) used in the cutting and welding of various metals such as steel, aluminum, and alloys. Equipment usage ranges from small retail to large plants.
  • Gas & Fluid Handling (49% of 2012 revenue) includes Howden and Colfax's legacy Fluid Handling businesses. Howden manufactures air and gas handling equipment for usage in the power, oil & gas, petrochemical, mining, process, and general industries. Products include centrifugal and axial fans, compressors, and rotary preheaters. Fluid Handling is a global supplier of pumps, pumping systems, and specialty valves. Fluid Handling is a leading manufacturer of rotary positive displacement pumps including screw pumps, gear pumps, and progressive cavity pumps.

 Investment Considerations:

  • Significant long-term earnings potential. Based on management’s long-term growth and margin targets, and assuming crisp execution on the ongoing corporate transformation following last year’s Charter acquisition, 2015 earnings power is ~$2.50-3.00+ on an organic basis. Further, future capital deployment (primarily M&A) could drive another ~$0.50-1.00 of EPS longer term. All in, we see potential long-term earnings power of $3.00-$4.00, driven by an attractive long-term organic growth profile, execution on Charter accretion/synergies, operational improvement across the platform, and capital deployment.
  • Attractive long-term organic revenue growth profile. Colfax anticipates long-term organic revenue growth of ~1-2% above GDP, driven by leading brands and market positions (No. 1 or No. 2 in virtually every end market it competes in), exposure to high-growth markets (50%+ of sales; oil & gas, power generation, mining), emerging markets expansion (50%+ of sales; mid- to-high-single-digit growth – among the highest in industrial group), aftermarket expansion (opportunity to further penetrate its installed base), and new product development (market leading technologies, driving greater customer switching costs). CFX’ end markets range from $1bn to $21bn and grow at a rate from 3-4% to 9-10%.
  • Substantial margin improvement potential. Management noted it remains in the early innings of its operational improvement plans and the Charter integration and restructuring initiatives appear to be on track. Management expects to drive $55-65 million in cost savings in 2013 (or ~$0.40 of accretion), with another $65-75 million realized in 2014 and 2015. Operational improvement opportunities will be driven by implementation of the company’s CBS (Colfax Business System) toolkit and lean processes, manufacturing plant consolidations, improved sourcing/supply chain, reduced headcount, and new leadership. Longer term, management sees Fluid Handling margins reaching 20%+ (currently mid teens), Howden margins expanding to mid teens (currently low teens), and ESAB margins moving to low teens (currently high single digits).  The company targets large markets where development and distribution of technologically differentiated products provide competitive advantages and lead to market leadership and higher, sustainable margins. Furthermore, the company operates in fragmented markets with no other competitor having the global/national presence that it has. The company faces a bit greater competition in the welding end markets.
  • Acquisitions remain a key growth driver. Colfax is in the early stages of its long-term transformation into a leading diversified industrial company, consistent with the lines of the Danaher business model. Similarly to Danaher, the company is focusing on developing internal talent, highly targeted acquisition strategy focusing on high growth markets and branded/technologically differentiated product categories, relentless pursuit of operational excellence. Colfax acquired Charter International in January 2012, which meaningfully increased the size of the company and added welding and air & gas handling platforms to complement the legacy Colfax fluid handling business. Over the next couple of years, Colfax expects to remain active in the M&A market, with plans to deploy ~$200-250 million annually, focused on bolt-on acquisitions and balanced across its three platforms. We also expect that longer term (24+ months out) management is interested in adding another strategic platform as it builds on its aspirations to transform into a leading diversified industrial company.

Risk Factors:

  • Macro economic conditions worldwide. Colfax's performance has been, and will be, adversely affected by macroeconomic weakness globally given the cyclical nature of its portfolio and the diversified nature of the company. Furthermore it has a relatively high exposure to Europe (offset by very high exposure to EM). Some investors are concerned about exposure to mining as well given China’s recent slowdown.
  • Highly competitive industry. Many of Colfax’s industries are highly competitive and fragmented, and competitors often target market share at the expense of margins in which case Colfax could be negatively impacted.
  • Changing technology. Approximately 50% of Colfax’s portfolio is exposed to the welding industry. A faster than anticipated transfer to automated or alternative welding processes (i.e., laser) and the inability of the company to respond quickly to changing market dynamics could adversely affect revenues and profitability. Furthermore it has exposure to coal-based power plants (environmental scrubbing technology) which could be threatened by stricter regulations.
  • Acquisition risk. Acquisitions have been and continue to be an important part of Colfax's long-term growth strategy. An acquisition-oriented growth strategy entails greater uncertainties than managing internal growth.
  • Higher leverage. The company has higher than historical leverage, however strong FCF generation should offset it.
  • Recent Earning Misses. The company has missed earnings in most quarters over the last year and half due to currency issues, delays in some shipments and acquisition integrations/ operations streamlining related issues.
 
Valuation:
 
Historically, CFX had a strong growth top line with relative stability (2009 revenues went down 13%).  Margins were high and so were ROIC. After the acquisition of Charter current pro forma margins are lower but the management has identified a number of cost cutting / streamlining opportunities to bring margins back to prior levels.The guidance appears achievable as it is driven primarily by cost saving. Assuming even very modest organic and relatively low incremental margins (compared to historical figures), the upside and LT EPS growth is quite impressive at 30+%.

 Furthermore, guidance seems achievable for the following reasons.

 Roughly 75% of Howden’s projected sales are in the backlog, with the remaining 25% representing aftermarket/flow business. While deliveries could get pushed out if the economy further softens, we see the 4-6% organic growth forecast as reasonably attainable. Currently the book to bill ratio is 1.01

  •  Roughly 50% of Fluid Handling projected sales are in the backlog. The company is not factoring in any contribution from the Keystone pipeline, which seems reasonable. Recent reports suggest that a decision on the pipeline is not expected until Jun/13 the earliest.
  •  Organic growth guidance of up 0-2% for ESAB appears conservative (comparatively, ITW is guiding its welding business to be up 4-6% organically this year). Given that welding is largely a short cycle business, sales could exceed expectations in 2H13 with a rebounding global economy.
  •  Interest expense guidance of $90mm assumes only ~$20mm of term debt principal repayment. Importantly, accordingly to recent press articles, Colfax is seeking to refinance its debt. While the discussion is on-going and terms are not yet available, we calculate that a 50bps rate reduction on the ~$1.7bn principal could add 5-6 cents to 2013 earnings (excluding associated one-time fees).
  • The company has outlined the cost savings it plans to achieve through the integration of the Charter acquisition (closing down 7 plants in Europe, reducing head count, implementing various efficiency programs (Kaizen, Kaban) etc)
Based on our Valuation we believe that within then next 18-24 months CFX will be worth $60-65 (based on 2015E estimates) and EV/ EBITDA multiples of 10x in line with comps  despite significantly better growth prospects. This is a high-quality growth company that can generate 20-25% CAGR a year in total investment returns
 
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

Executing on Charter acquisition cost savings
Additional acquisitions
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    Description

    Summary Thesis: Colfax Corporation (Colfax or CFX) is a diversified industrial companies with a strong and sustainable market positioning operating in high growth end markets and regions. It is pursuing the successful business model pioneered by the likes of Danaher and Roper whereby the management is focusing on building, both organically and through acquisitions, a portfolio of highly differentiated products with superior brands and technologies targeting large high growth markets in which performance and quality matter. Through continuous investment in developing internal talent and relentlessly focused on streamlining operations and improving efficiency, the company plans to generate very high EPS growth 25-30% CAGR over the next 3+ years.  The guidance seems achievable and it is predicated mainly on cost savings via the integration of the recent transformational Charter acquisition.  The multiples are in line with comparable companies, despite the higher growth.  Overall we believe this company can generate 20-25% CAGR of total investment returns over the next 2-3 years and it is therefore recommended for purchase.

    Company Description:

    Colfax was formed in 1995 and has completed a number of acquisitions and divestitures to strategically focus the business. The most recent transaction of Charter International (January 2012) roughly quadrupled the company’s revenue base and is consistent with Colfax’s plan to become a large, diversified industrial company. Colfax has two reportable segments:

     Investment Considerations:

    Risk Factors:

     
    Valuation:
     
    Historically, CFX had a strong growth top line with relative stability (2009 revenues went down 13%).  Margins were high and so were ROIC. After the acquisition of Charter current pro forma margins are lower but the management has identified a number of cost cutting / streamlining opportunities to bring margins back to prior levels.The guidance appears achievable as it is driven primarily by cost saving. Assuming even very modest organic and relatively low incremental margins (compared to historical figures), the upside and LT EPS growth is quite impressive at 30+%.

     Furthermore, guidance seems achievable for the following reasons.

     Roughly 75% of Howden’s projected sales are in the backlog, with the remaining 25% representing aftermarket/flow business. While deliveries could get pushed out if the economy further softens, we see the 4-6% organic growth forecast as reasonably attainable. Currently the book to bill ratio is 1.01

    Based on our Valuation we believe that within then next 18-24 months CFX will be worth $60-65 (based on 2015E estimates) and EV/ EBITDA multiples of 10x in line with comps  despite significantly better growth prospects. This is a high-quality growth company that can generate 20-25% CAGR a year in total investment returns
     
    I do not hold a position of employment, directorship, or consultancy with the issuer.
    Neither I nor others I advise hold a material investment in the issuer's securities.

    Catalyst

    Executing on Charter acquisition cost savings
    Additional acquisitions

    Messages


    SubjectWhat am I missing on CFX?
    Entry03/08/2013 06:04 PM
    Memberroc924

    I feel like I’m missing the big picture bull case here. Of course the same could be said for a lot of stocks I’m looking at, like CRM.

     

    Colfax missed on the top line in 4Q, sales declined on an organic basis, analysts’ cut earnings estimates 7% for this year and 9% for 2014 in the last 90 days, and the company missed on 4Q earnings with 33c of earnings (excluding the unexpected tax benefit) versus a 39c estimate. And after a short lived drop, the stock is hitting all time highs. I am being sincere when I ask: what am I missing?

     

    In more detail, Colfax’s organic sales declined 2.5% y/y in 4Q and came in below consensus revenue in both of the last two quarters. Orders were up 1.9%y/y in 4Q, but a deceleration from +3.1% for the 9mos ended Sept12. Business has clearly slowed. What in the big picture is going to change this year so orders/sales reaccelerate in the next couple years to hit your/management’s growth targets?

     

    Also, ESAB declined in 4Q by 2% organically; what is the basis for a pick up to 0-2% or ITW’s 4-6% in 2013?

     

    I was also hoping you could help me understand the margin expansion. You wrote "Longer term, management sees Fluid Handling margins reaching 20%+ (currently mid teens), Howden margins expanding to mid teens (currently low teens), and ESAB margins moving to low teens (currently high single digits)." I was wondering, what margins do competitors earn? And/or is there something else to support the businesses earning these margins besides management's forecast?

     

    You wrote that margins were high and so were ROIC. Over what time period were you looking at? 2007 looks like the only strong year I see. Over a longer period I see a business with negative retained earnings since at least 2006 when they were -$142M. Retained earnings today are negative $139M. The company has paid no dividends and shares outstanding went up almost 5x from 22m in 2006 to 107m fully diluted today. Maybe I’m missing something but what I see is that ROIC/ROA has been volatile and low; the return on assets in the last 7 cumulative years was negative. I know this business has changed a lot in the past few years, but when did it have high ROIC over a full cycle and why is this going to be a good business in the future?

     

    Shares outstanding as of 12/31/2012 are indeed 94m as you show, but what about options and the convertible preferred stock? The company has preferred that is convertible into 12.2m shares. And there are 2.2m options outstanding with a $25 average strike price. There are .5m unvested RSUs you could add too. You show in the write up that the company has zero cash or debt. At 12/31/12 there was $482m of cash and $1,729 of debt for net debt of $1.2B. The company has unfunded pension and other retirement benefits of $413m. Using the price in your write-up I show an EV of about $6.2B including the underfunded pension/retirement benefits.

     

    Can you expand more on valuation? Which comps are at 10x EBITDA? What enterprise value and EBITDA are you using to arrive at a $60-65 target in 2015? Using $62.50 stock price, the existing capital structure (this is quite generous for a company that has expanded share count by five-fold in a few years), and the 10x multiple you cite results in EBITDA of about $835m ($800m excluding the underfunded pension from debt). The consensus EBITDA is $723m in 2015. If EBITDA goes to $835 in 2015 as your numbers imply, wouldn’t that be a cyclical peak and if so, do the comps trade at 10x on cyclical peak EBITDA?

     

    And do the comps trade at 10x on a forward basis or a trailing basis? This matters a lot for your cited ROI of 20-25%. If it is a trailing basis and assuming everything else you have written is correct, the ROI drops to 13% from your 20-25% (3 years instead of 2).

     

    You commented on “relative stability” in 2009. The operating income of Colfax plummeted over 60% excluding asbestos expenses/income from 2007 to 2008. While in 2009 the company was much different and this was before the Charter acquisition (and many other acquisitions), Charter operating income was down over 50% in 2009.

     

    Thanks in advance.

     

     

     

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