With process industries, aerospace, and retail/leisure activity picking up, it shouldn’t be altogether surprising that Crane (NYSE:CR) shares are doing better, particularly when management execution seems to be improving as well. Relative to my last update on the shares, Crane is up about 8%, beating the S&P 500 as well as the broader industrial sector (by close to 10%).
I don’t think Crane’s run is over yet. Process industries are just starting to recover, and even if the market is anticipating that, there are opportunities to grow the business and boost margins. Aerospace is just starting on what should be a nearly decade-long growth cycle, and recovering retail activity and acute labor pressures should drive more growth in the Payment & Merchandising Technologies (or PMT) business. On top of that, there’s margin leverage and capital redeployment potential here, and I can see a path to double-digit annualized returns from here.
Aerospace Cleared For Takeoff
Aerospace is likely the biggest incremental driver for Crane over the next several years. Not only has this segment been under-contributing at the top line due to the sharp decline in commercial aerospace during the pandemic, but at scale this is far and away the most profitable business, with segment margins in the low-to-mid-20%’s versus company-wide margins in the mid-teens.
Parker-Hannifin (PH) recently guided for 18,000 aircraft builds between now and 2030, and other major aerospace suppliers have guided broadly similarly, with narrowbody production expected to accelerate throughout 2022 (and beyond) and widebody picking up in 2023/2024.
Crane is a leading producer of landing systems (brakes in particular), with content on every Boeing (BA) plane going back over 60 years, as well as content on other OEMs. Crane also has a meaningful position in sensing, with again broad content across manufacturers. In addition, I wonder if Crane could be poised for incremental second-sourcing wins, as Parker’s acquisition of Meggitt will take away an option in sensing, utility systems, and fluid management. I also see attractive long-term opportunities in thermal management (an area Parker has targeted as well).
Military business has been an erratic contributor to Crane’s results, but that’s the nature of the business. Crane recently won a major contract to upgrade the brake controls on F-16 fighters worth about $84M, and that deal won’t kick in until 2026.
Let The Process Play Out
While I’ve been advising patience with respect to many other process/fluid control companies in the wake of not-so-great Q4’21 sales, that’s not the case with Crane. This company saw 15% year-over-growth in the last quarter, outperforming the 7% growth in IDEX’s (IEX) Fluid & Metering Tech business, the 1% growth in Final Control at Emerson (EMR), and the 4% decline in ITT’s (ITT) Industrial Process segment.
The specific end-market and product exposures can explain some of this, but Crane is already benefiting from improving demand from the chemical, pharmaceutical, and general industrial markets, as it’s not as sensitive to project-oriented orders. Power and refining are still soft, and I would expect further improvement.
Process is a business where I’d like to hear more about management’s long-term plans. I see opportunities to grow by expanding the served addressable market, as Crane only serves about one-quarter of its potential market, and markets like factory automation and mobile hydraulics should be addressable without significant M&A, but will take time to develop.
Labor And Increased Spending Should Drive PMT
PMT was hit hard by the pandemic, as consumers significantly reduced their shopping at physical locations, reducing the need for banknotes and new kiosks, and likewise stopped using vending machines (due to work/study at home) and going to leisure locations like casinos.
Much of that is now reversing, although the vending market is still not back to normal. The Fed’s banknote order for fiscal ’22 was admittedly wide (down 4% to up 34% versus FY’21), but that’s typical and although actual printing has been on the lower end of the order range in recent years, I think that will have to increase to keep pace with increasing in-person commercial activities, even as non-cash payment alternatives continue to gain share. I also expect to see meaningful ongoing interest in automated systems, as retail continues to deal with labor shortages, and I likewise believe banks’ ongoing desire to cut branches (in the U.S. and Europe) is supportive of more ATM-based demand.
The Outlook
I’m not entirely sure what to expect at the upcoming Investor Day (March 30), but I believe it would serve management’s interests to make a good case for why/how Crane makes sense as it is presently constructed, as opposed to breaking it up and either spinning or selling the parts – there just aren’t many obvious synergies between process control, cash-based payment technologies, and aerospace, and conglomerates increasingly have to “earn” the right to remain conglomerates.
I’d also like to hear more about growth opportunities/strategies in process and aerospace, particularly as Crane’s balance sheet can support M&A.
I would also note a potential negative development – last Thursday (March 17), the DOJ moved to block the sale of Crane’s Engineered Materials business to Grupo Verzatec on antitrust grounds. This was a good exit for Crane from a business that had been an underperforming drag for some time.
Given a somewhat better (or at least earlier) recovery in process and a strong cyclical outlook for aerospace, I’m a little more bullish with my modeling now. My FY’22 and FY’23 revenue doesn’t change much at all, but changes to later years move my long-term growth estimate a little closer to 4%.
Interestingly, the Street seems less bullish on the revenue outlook, despite the later-cycle uplift from process and the growth acceleration in aerospace, but is more bullish on margins. I’m looking for about two points of EBITDA improvement from 2021 to 2024, as well as FCF margin improvement toward the mid-teens over the next seven to 10 years – the Street is looking for around 15% FCF margins as quickly as FY’24.
The Bottom Line
Discounted cash flow gives me an estimated 10% total long-term annualized return potential on 4%-ish revenue growth and around 7% FCF growth, while Crane’s near-term margins and returns (ROIC, et al) should support a forward EBITDA multiple close to 13.25x – a multiple that would support a fair value in the mid-$140s, well above the high end of the Street.
I really don’t see much at Crane that worries me today, and I like the fact that management has been returning cash (via dividend and buyback) while waiting to find the right M&A opportunities. Given acceleration across all three major business lines, and the significant incremental margin potential in aerospace, I think this is a name still worth considering.
