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Overview and Investment Thesis:
Milacron is a global leader in the manufacture, distribution, and service of highly engineered and customized systems within the $27 billion plastic technology and processing industry. Milacron is a busted IPO with shares currently down over 30% from its 2015 IPO price of $20 a share. However, following a multi-year restructuring that ended in December 2018 intended to drive growth and improve profitability, the Company’s strong free cash flow generating abilities should become apparent especially due to the absence of meaningful one-time expenses incurred during each of the past two years. At current levels, shares offer investors a FCF yield of ~10% based on the Company’s 2019E FCF. The Company’s free cash flow generating abilities should be fairly resilient going forward with about two-thirds of overall revenues generated from higher margin consumable sources (up from 44% in 2011) and a longer-term target of 75% from this revenue source. A large amount of the Company’s excess capital in recent years has been deployed for debt reduction with net debt/EBITDA declining to 2.9x at year-end 2018 from 4.8x in 2014. Going forward, we would expect the Company to return a meaningful amount of its excess capital to shareholders and we note that in November 2018 Milacron announced a $125 million share repurchase authorization just as its restructuring activities were coming to an end.
Why Does This Opportunity Exist:
History and Background:
Some of the longer-tenured VIC members may recall Cincinnati Milacron, the predecessor to Milacron. That Company had a long and storied history in the manufacturing industry having been formed in 1860 and was initially known as the Cincinnati Milling Machine Company. By 1922, the Company became the largest machine tool company. After World War II, the Company began diversifying its business and developed machine tools for a wide range of industries including aviation (specialty aircraft parts) and electronics (circuit boards for radios and televisions). In the 1960s the Company expanded its business into the growing market for plastic processing equipment and developed a line of injection molding equipment. In 1970, the Company changed its name to Cincinnati Milacron, because its old name (Cincinnati Milling) no longer reflected the Company’s now diverse business mix. The new name capitalized on Cincinnati’s reputation for a city associated with machine tools, with the roots of the word Milacron meaning highest precision. The Company bolstered its plastics processing business in the 1990s with a number of acquisitions. With the Company focusing on the plastics business, it sold the majority of its metalworking businesses (with the exception of what is now MCRN’s Fluids business). Following the exit from its machine tool business, the Company changed its name to Milacron in 1998.
After a period of consistent growth between the 1960s and 1990s, the plastics industry was challenged in the early 2000s due to reduced spending by its customers. The 2008/2009 downturn created additional pressures for its core customers who struggled to obtain financing for equipment purchases. Although Milacron maintained strong market positions during the downturn, lower equipment sales from reduced global demand for new machines, coupled with outsized debt and a large underfunded pension plan, ultimately led the Company to file for bankruptcy in March 2009.
Milacron emerged from bankruptcy in August 2009 with a clean balance sheet, reduced legacy costs and a strong competitive position and the Company began attracting additional management talent and stepped up its investment in R&D. The business quickly regained its leading market share in North America, and it continued to invest throughout this period with a view to expanding its position in emerging markets, particularly in India.
In 2012, Milacron was sold to CCMP Capital, a private equity firm spun out of J.P. Morgan in 2006. In conjunction with the acquisition by CCMP, plastics industry veteran Ira Boots, who had retired from Berry Plastics (a Milacron customer) in April 2012, was appointed chairman of the Company, a position he continues to hold. Mr. Boots boasts a long tenure in the plastics industry and was elected to the Plastics Hall of Fame in 2018. During Mr. Boots’s tenure at Berry between 2000 and 2010, he led that company through three private equity owners. A key component of CCMP’s turnaround initiatives for Milacron was the increase in consumables revenue. In March 2013, MCRN acquired Mold-Masters for nearly $1 billion, a transaction that significantly bolstered the companies consumables revenue with Mold-Masters generating all of its revenue from consumable sources. During 2011, consumables accounted for 44% of MCRN’s total revenues, but this source currently represents ~66% of the Company’s total revenues. Following Milacron’s 2015 IPO, CCMP owned an ~62% stake in the Company, but CCMP sold down its Milacron stake via multiple secondary offerings subsequent to the IPO, completely exiting its stake in November 2017. With the PE ownership overhang lifted, we believe that Milacron could be a candidate for future inclusion in an S&P index, which could help increase investor awareness of the Company.
Business and Industry Overview:
The Company’s equipment and systems are used to make plastic parts/goods for a wide range of industries including automotive (bumpers, door handles, etc.), packaging (food storage, beverage caps), consumer goods (toothbrushes, housewares, appliances, etc.), electronics (cell phone components and accessories, etc.) and medical (tubing, beds, syringes, medical waste containers, etc.).
The plastics processing industry is highly fragmented with 15 companies (including Milacron) accounting for 33% of the industry’s total sales (~$27 billion). Within the industry Milacron boasts market leading positions in a number of areas including:
#1 supplier to its installed base worldwide, by sales
#1 supplier of injection molding technologies in India, by sales
#1 provider of hot runner systems in the Americas and Europe, by sales
#2 provider of hot runner systems in Asia, by sales
Milacron’s sales are diversified by geography and end market. During 2018, MCRN generated 50% of its sales from North America, followed by Europe (19%), China (12%), India (10%) and the rest of the world (9%). The Company’s largest customer accounts for just 1.2% of total sales and its top 10 customers account for <7% of total sales. Key end markets include automotive (16% of total sales), packaging (15%) and consumer goods (13%). Although automotive exposure may create some unease, new product models (the outlook for which is very favorable) rather than volumes tend to be a key driver of the Company’s results from its automotive business. MCRN generates roughly 66% of its revenues (~80% of adjusted EBITDA) from consumable products (parts and services, hot runner systems, equipment upgrades and overhauls) with the balance from equipment. Milacron expects that it will continue to increase the percentage of sales it derives from consumables with a longer-term target of 75%, well up from 44% of revenues it generated from consumable sources in 2011. This should have a favorable impact on the Company’s overall profitability with consumables commanding significantly higher gross margins (30% to 50%) compared with equipment sales (between 20% and 30%).
The Company classifies its results into the following three segments:
Fluid Technologies: during 2018 the Company’s fluid technologies (Fluids) segment generated 10% of overall sales (22.7% pre-corporate EBITDA margin). The company’s fluid technologies aid manufacturing operations by providing more machine uptime and by allowing for production of more parts of higher quality in less time. Although this Fluids business has a solid competitive position, generates good margins and produces solid cash flow, it is non-core to the Company’s plastics processing business and therefore we would not be surprised if the business was sold in the coming years.
The following is a link to a video that provides a good overview on injection molding/hot runners, which are an integral part of MCRN’s business.
Plastic Injection Molding:
Meaningful Competitive Advantages:
in our view, Milacron offers meaningful competitive advantages that should not only help sustain its current market position, but provide good future growth opportunities as it capitalizes on a number of promising industry trends (discussed in a later section). Among the Company’s competitive advantages include its strong brands (Milacron, Mold-Masters, DME, etc.) that have been in existence for 70 years on average, large installed base (40k machines and 150k hot runner systems globally) providing an ample future consumable revenue opportunity, strong portfolio of IP ( ~1,000 patents) and leading support capabilities (customers have 24-hour access to the Company’s engineering capabilities), long term relationships with blue chip clients (MCRN has served many of its top customers for over 30 years), and a management team with significant industry experience (senior managers have an average of 30 years of plastics industry experience).
Improved Cost Structure and Consumables Revenue Growth Drives Margin Expansion:
In December 2018, MCRN wrapped up a multi-year restructuring that eliminated $35 million in fixed costs from its business. As part of this restructuring, MCRN closed three manufacturing plants in Europe and expanded its plants/presence in India and China. The Company also consolidated many back-office functions from the U.S. and Europe to India. In addition, the Company has also reduced the cost to manufacture its equipment by exiting lower-margin/unprofitable product lines and eliminating unnecessary (but high cost) features from its products.
In addition to cost savings, growth in consumables revenue sources should help improve future profitability and drive EBITDA margins over management's longer term target of 20% (up from ~18.2% currently) and well up from 16.4% posted in 2014. As previously noted, the Company’s APPT segment generates a majority of its revenues from equipment sales, but there is a meaningful consumable revenue opportunity. During the Company’s 4Q 2018 earnings call, CEO Tom Goeke stated that the value of consumables revenue across the life of the Company’s machines is approximately four times the original cost of a machine over a 20 year period. Milacron’s current installed base of equipment currently generates ~$500 million in aftermarket/consumable revenues, and MCRN captures about 25% of this amount. Meanwhile, the aftermarket opportunity of its competitor’s machines (~260k) is over $1 billion and MCRN is capturing very little of this amount. In our view, MCRN should be well positioned to capture additional aftermarket revenue thanks to recent initiatives to increase parts availability and lower lead times including placing serial numbers not only on its parts, but parts it distributes. It is also worth noting that MCRN has the largest field service organization serving the plastics industry and is also the only remaining plastics equipment manufacturer in North America. Milacron is also adding new technicians global to capture future aftermarket revenues having added more than 30 new technicians since 2014.
Increased penetration of hot runners should also bolster the Company’s consumable revenue mix. Although hot runner systems are more costly than cold runner systems from the perspective of MCRN’s customers, they offer a number of significant benefits that result in meaningful savings over the longer term (see link provided below for additional detail). Penetration of hot runners in developed markets such as Japan, Europe, and the U.S. ranges from ~60-80%, while penetration in China currently stands at ~55%, leaving plenty of room for future growth. Importantly, hot runners offer margins that are “well above” company averages so their future growth should have a favorable impact on MCRN’s future profitability.
Hot Runners vs Cold Runners: Why You Should Be Using a Hot Runner System:
In our view, MCRN is well positioned to benefit from powerful secular trends in the plastics industry including:
Conversion of medical devices to plastic for safety and disposability considerations
Transition of food and beverage packaging from glass and metal to plastic
Reduced lifecycles for electronics products
Design flexibility for consumer goods and appliances
The use of plastic for construction and infrastructure
Increased purchasing power in emerging markets (per capita income growth is a major driver of plastics consumption)
In April 2019, the Company announced that it would be divesting its blow molding business line. During 2018, the blow molding business generated approximately $90 million in sales and approximately $9 million in adjusted EBITDA. In announcing the decision to divest the business, MCRN CFO Bruce Chalmers stated that the board/management felt that it was in the best interest of its shareholders to focus on the injection and extrusion businesses within the APPT segment, which are better aligned with the Company’s objectives of achieving consistent 5% top line growth and 20% EBITDA margins. Management noted that the blow molding business has been difficult to forecast and has not met its profitability targets. The blow molding business was expected to contribute ~$10 million in free cash flow in 2019 and as a result management lowered its full year FCF outlook to between $90 and $100 million (FCF yield of ~10% at the mid point) in conjunction with the divestiture announcement.
Valuation: What’s it Worth?
At current levels, MCRN trades at just ~7x 2018 EBITDA. In our view, this valuation is inconsistent with the Company’s strong level of profitability (18%+ EBITDA margins), strong competitive position, low capital intensity (capex/revenues: ~3.0%) and good future growth opportunities. Applying a 9x multiple to our estimate of the Company’s 2021 EBITDA for the higher margin MDCS (~30% pre-corporate EBITDA margin) and Fluids (~23%) segments and a 7x multiple to the APPT (~13%) segment’s 2021E EBITDA results in a value of $22 a share, representing nearly 60% upside from current levels. With leverage at manageable levels coupled with the Company’s strong FCF, we would not be surprised to see the Company become an aquisition targe, espeically if the MCRN shares continue to languish.
Reduced demand for plastics due to lower economic growth and/or environmental considerations
Increased prices of plastic resin, which tend to negatively impact customers’ margins and might reduce demand for Milacron products
A downturn in one or more of the Company’s end markets (many Milacron customers operate in cyclical businesses) that negatively impacts demand for the Company’s products
Adverse FX movements
Continued margin expansion due to higher levels of consumables revenue, benefits from recent cost saving initiatives, and a recent business divestiture
Divestiture of non-core Fluids business
Outsized buybacks following recent share repurchase authorization as leverage levels have declined meaningfully in recent years
Increased investor awareness including potential inclusion in a major S&P index
Bolt-on/tuck-in acquisitions that enhance the Company’s competitive position
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