OldSchoolValue (< 20)

The Timken Company (TKR) – Growth through acquisitions

January 06, 2012 – Comments (0) | RELATED TICKERS: TKR

Original with proper formatting.

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The Timken Company (Timken) develops, manufactures, markets and sells products for friction management and power transmission, alloy steels and steel components. Timken’s portfolio includes a range of friction management products and maintenance services. The Company also manufactures power transmission components and assemblies, as well as systems, such as helicopter transmissions, alloy steel, bars and tubing, and finished and semi-finished steel components. Timken’s global footprint consists of 52 manufacturing facilities, nine technology and engineering centers, 14 distribution centers. The Company operates under two business groups: the Steel Group, and the Bearings and Power Transmission Group. The Bearings and Power Transmission Group consists of three operating segments: Mobile Industries, Process Industries, and Aerospace and Defense. In September 2010, the Company acquired QM Bearings and Power Transmission, Inc. In October 2011, the Company acquired Drives LLC.

Why is it Cheap?

IMO TKR is only cheap if it can continue to meet expectations in growth and performance. Otherwise, not cheap.As of now if I consider limited growth, TKR is overvalued.

Management

Total insider ownership is 10% of the company.Timken family owns 10.4% of stock.Total exec compensation is 0.5% of total revenue from 2010. Larger companies have small % as it should be.Management seems to rarely buy any stocks on open market. Plenty of option exercises.Small but consistent share dilution through options.

Growth

Growth coming through acquisitions. Historically TKR makes acquisitions every year. The Company’s acquisition strategy is directed at complementing its existing portfolio and expanding the Company’s market position. These businesses in boring industries that make acquisitions have tended to do well though.Made 2 acquisitions in 2011 which added to EPS. Underlying original business is essentially flat otherwise.Capex is expected to increase to $200m in 2011 vs $110m in 2010

Strategic Advantage / Moat

seeing as how their main option is to grow through acquisitions, I don't see much of a moat or strategic advantage other than trying to buy out smaller competitors.Business in general is low margin which doesn't indicate much of an obvious advantage.

Competitors

One of the bigger players in the market.Industrial industry is very fragmented though. Lots of custom work required.In terms of competitors, they should be good.Nothing alarming here.

Risks

Joint ventureMakes small equity investmensts which are pretty bad. Had to write down certain investments completely. Management ability not that great imo.Quite a lot of liability accruals built up. Could be used as a cookie jar if the liabilities never occur.Workers are in a union.Pension and other postretirement contributions is going to double vs 2010 from $230m to ~$420m.

Valuation

ROE if you exclude 2009 is 12%ROIC and CROIC isn't impressive historically. In the single digits.
Nothing special. If a company is leveraged and is only making these
types of returns, then it's even worse. TKR is fairly leveraged with debt/total assets being 60%. LT debt is 19% of total assets as of 2010 annual report.Asset turnover has decreased over past 2 yearsCash has increased though.FCF is expected to decrease considerably.If everything goes according to plan and the growth capex succeeds in increasing FCF to around $300m, then with 12% discount, implied growth expectation is approx 10%. If FCF turns out to be $200m, then company has to grow at 15% to match current stock price. That is a 50% difference. Far too much. in other words, quite risky.However story is different on EPS because of the many acquisitions.Using EPS of expected $4.60 forward earnings, the market is implying a growth of measly 2%.With $3 EPS, implied growth is 7%.Cash flow wise, valuation is around $25ish. Earnings valuation gives about $50 ish.

Catalysts

Company has a joint venture which could be blockbuster (i doubt it)Acqusitions continue to add bursts of EPS that drive the stock up.

Conclusion

Big player in a fragmented industry buying small competitors for growth. Acquisitions are done strategically to fit certain niche markets for growth. Company overall isn't the best. It has mediocre numbers and operations with low margins, low erratic cash flows, very capital intensive. But acquisitions are adding to EPS which is boosting the stock price and makes it seems cheap.

Question is, can it be sustained? Margin for error is too small as the intrinsic value range is too wide based on small mistakes.

Verdict

Management: CGrowth: B-Moat: BRisk:B-Valuation: BOverall: B-

It's either a hit or miss with this. 50-50 probabilities aren't good enough in investing.

Other Links

http://seekingalpha.com/articl…..tock-gains