April 24, 2021 - 4:12pm EST by
2021 2022
Price: 17.39 EPS 1.15 1.30
Shares Out. (in M): 293 P/E 15.1 13.4
Market Cap (in $M): 5,095 P/FCF 17 14
Net Debt (in $M): 2,187 EBIT 655 705
TEV (in $M): 7,282 TEV/EBIT 11.1 10.3

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Investment Thesis:


Gates will benefit from a worldwide boom in industrial production.  Although the stock has performed very well in recent months, it still trades below its 2018 IPO price and has a reasonable valuation on projected earnings and free cash flow.  By the end of 2021 the company should have reduced its debt below its target of 3X EBITDA, creating opportunities for accretive acquisitions in its very fragmented markets, share buybacks, and/or a potential dividend.  Against what I firmly believe will be a backdrop of declining market valuations, Gates should be able to appreciate 30-40% over the next 18-24 months.  


History and Background:


The company is 110 years old and based in Denver, where Charles Gates acquired a tire and rubber company.  Several years later, his brother John invented the V-belt made of rubber and woven threading as a replacement for the hemp and rope belts then used on autos and machinery.  To this day, the company remains the largest manufacturer of V-belts and materials technology is at its heart.  It is a very international business and sales are reasonably correlated with worldwide industrial production.


Tomkins, a British conglomerate, bought the family controlled company in 1996.  In 2010, Onex teamed with the Canadian Pension Plan Investment Board, to buy Tomkins.  Four years later, Blackstone bought Gates for $5.4 billion.  Blackstone took Gates public in early 2018.  After a follow on offering this February (all secondary stock), Blackstone owns 76% of Gates.  




Gates divides itself into two segments;  Power Transmission (64% of sales) and Fluid Power (36%).  Power Transmission has somewhat better margins and Gates has a more commanding presence here--management asserts it has the leading worldwide market share and is one of the top three in fluid power,  They also believe that 42% of sales are in products where Gates has a leading market position and 83% where it is a top three player. It is important to recognize, though, that both markets are very fragmented.  Over 60% of company-wide sales come from replacement markets. One perceived negative is automotive exposure, although only 2% of sales come from first-fit North American auto sales.  A potential positive is that the available content to Gates products on hybrids and fully electric cars is greater than on internal combustion engines.


The common characteristic of the myriad products Gates manufactures is that they are essential to the operation of the machines and vehicles in which they are used.  Application engineering and materials science is at the heart of the company.  The company is very profitable (current EBITDA margins are about 21%; the peak was 22.8% in 2018 and management has a target of 24%) and the business is not very capital intensive. Even in 2020, the company generated meaningful free cash:  $0.86/share, although some of this came from working capital reductions.


Outlook and Price Target:


Management has guided 9-14% sales growth for 2021.  I think mid single-digit growth should be possible over the next couple of years and EBITDA margins, on that assumption, should reach 23%--still a little short of corporate goals. With accompanying balance sheet improvement, more seasoning as a public company and the likelihood of more float I think that 10-11X EBITDA is a very realistic multiple even in a more challenging market, which would get the stock to the low-mid $20s.  Though I am not in love with EBITDA as a valuation tool, I think it makes sense in this case given the heavy burden of goodwill amortization and the low capital requirements of the business.  


Note: I have added back goodwill amortization (about $130MM/year) in the EBIT projections above.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


1.  Strong sales and earnings growth.  2.  Debt reduction to under 3X EBITDA by the end of this year.

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