Hillenbrand: Not A Buy At The Current Levels (NYSE:HI)

Funding thesis

Hillenbrand (NYSE:HI) is anticipated to learn from the conversion of its record-high backlog into income within the coming quarters. Nonetheless, as a result of macroeconomic slowdown, order progress ought to gradual and begin impacting backlog and income within the medium time period. The leverage is also on the upper facet which ought to influence inorganic progress prospects.

On the margin entrance, the corporate ought to expertise a lower in EBITDA margin as a result of dilutive influence of the value/value equation, quantity deleverage within the MTS phase, and the dilutive influence of decrease margin acquisitions within the APS phase. Nonetheless, in the long run, margins are anticipated to enhance as the corporate realizes synergy advantages from these acquisitions and focuses on rising aftermarket enterprise.

The corporate is at the moment buying and selling at a better than historic valuation. Whereas I just like the long-term prospects, blended near-term outlook and better valuations preserve me on the sidelines.

Income Outlook

Hillenbrand skilled good income progress post-pandemic, pushed by wholesome demand in finish markets similar to car, development, medical, and electronics, for each short-cycle and long-cycle initiatives. This momentum continued in early FY22. Nonetheless, within the second half of FY22 and 1Q23, the corporate began seeing some weak point within the MTS phase’s orders as a result of macroeconomic slowdown.

Supply: Firm knowledge, GS Analytics Analysis.

Wanting forward, the corporate’s income progress outlook is blended. Whereas the file backlog is anticipated to drive income progress within the close to time period, weakening order progress ought to begin to influence backlog and income progress within the medium time period.

Hillenbrand’s backlog has reached a file excessive of ~$1.95 billion, which incorporates ~$240 million of backlog from current acquisitions. The sturdy order progress and provide chain constraints in recent times had been the first causes behind this file backlog. Though some provide chain issues persist, notably in digital elements and chips, they’re typically bettering. I imagine that these provide chain points will proceed to enhance all through FY23, leading to a better backlog conversion charge and benefiting the corporate’s prime line within the close to time period.

Within the medium time period, the current macroeconomic slowdown is anticipated to end in weak order progress for Hillenbrand within the coming quarters which ought to ultimately begin impacting backlog and income. Throughout 4Q22 and 1Q23, the MTS phase witnessed decrease demand from short-cycle initiatives as a result of weak macroeconomic situations, leading to undertaking delays and a sequential decline of 13.3% and 6.1% within the phase’s backlog for 4Q22 and 1Q23, respectively. Whereas the APS phase has fared significantly better until now as a result of continued energy in long-cycle initiatives, if the present slowdown is extended, it might end in order slowdown on this enterprise as nicely.

The corporate’s progress in recent times additionally has been aided by M&As. The acquisitions of Linxis, Peerless, Gabler, and Herbold expanded the corporate’s presence within the high-growth recycling and meals trade and grew the corporate’s income from these finish markets from ~$100 million to ~$530 million. The acquisition of Herbold expanded the corporate’s recycling capabilities, making it a turnkey service supplier within the plastic recycling house, whereas the acquisitions of Linxis, Peerless, and Gabler expanded the corporate’s capabilities within the meals processing finish market.

Nonetheless, this inorganic tailwind is also more likely to be subdued over the subsequent couple of years. The corporate’s web debt to EBITDA ratio is at the moment ~2.6x, close to the higher finish of administration’s goal vary of 1.7-2.7x. Given the excessive debt degree and unsure macroeconomic situations within the close to time period, it is unlikely that administration would pursue additional acquisitions within the close to time period.

Whereas I like the corporate’s long-term progress story across the growing use of engineered plastic in varied industries to cater to growing demand from the rising center class particularly in Asia, its close to to medium-term income outlook stays blended.

Margin Outlook

Throughout 1Q23, the corporate skilled a 40 bps YoY lower in adjusted EBITDA margins to fifteen.4%, primarily as a result of dilutive impact of worth/value. On a segmental foundation, the APS phase witnessed a ten bps YoY enhance in adjusted EBITDA margins to 17.3%, primarily as a result of productiveness enhancements, partially offset by dilutive mid-teen EBITDA margins from the acquisitions. However, the MTS phase witnessed a 310 bps YoY lower in adjusted EBITDA margin to 17.7%, primarily as a result of inflation and quantity deleverage.

Wanting forward, the corporate’s EBITDA margin is anticipated to be impacted by a number of elements, together with dilutive worth/value, quantity deleverage within the MTS phase, and the dilutive influence of acquisitions within the APS phase.

The corporate has been coping with greater enter prices as a result of rising inflation. Whereas the corporate has been capable of enhance product pricing to offset the rise in enter value and preserve the gross greenback degree profitability, the online influence is dilutive to the margins, leading to a ten bps YoY margin headwind within the first quarter of FY23. This pattern is anticipated to proceed all year long, with worth/value remaining a headwind for EBITDA margins.

As well as, the MTS phase’s EBITDA margins are anticipated to be underneath stress as a result of quantity deleverage. The phase has reported a decline within the backlog for 2 consecutive quarters, and the sluggish demand is anticipated to proceed leading to a quantity decline for the 12 months. Administration anticipates that the lower in quantity will influence the phase’s EBITDA margins, that are anticipated to say no between 70bps and 170 bps YoY. Moreover, the inclusion of lower-margin enterprise within the APS phase is anticipated to influence the phase’s adjusted EBITDA margins, with administration forecasting a YoY change of -60 bps to +40 bps.

Over the medium to long run, the corporate’s EBITDA margins are anticipated to learn from an elevated mixture of aftermarket income and synergy advantages arising from current acquisitions.

The corporate sells capital tools that may have a lifetime of as much as 30 years. Nonetheless, this tools must be serviced every so often, making a stream of aftermarket income for the corporate, which comes a considerably greater margin. The administration plans to develop its aftermarket income from $730 million to $900 million by 2025. This enterprise is anticipated to develop sooner than the capital tools enterprise progress, as the corporate is targeted on bettering servicing capability, designing merchandise which have greater aftermarket potential, and providing service contracts.

Furthermore, the corporate’s EBITDA margins are anticipated to enhance as a result of synergy advantages from just lately acquired corporations. LINXIS, Peerless, Gabler, and Herbold had a mixed EBITDA margin of ~15%, which is nicely beneath the 19-20% EBITDA margin of the APS phase. The corporate has beforehand realized vital synergy advantages from acquisitions, such because the Coperion acquisition, which noticed a 700bps margin enchancment post-acquisition, and the more moderen acquisition of Milacron enterprise, which noticed a 200bps margin enchancment post-acquisition. Related synergy realization is anticipated from the current acquisitions.

So, the long-term margin outlook is nice however there are some challenges within the close to time period.

Valuation

The inventory is at the moment buying and selling at a ahead P/E of 15.19x based mostly on the FY23 consensus EPS estimate of $3.14, which is greater than its five-year common of 13.75x. The corporate has blended income and margin outlook. Whereas income ought to profit from a wholesome backlog and sooner backlog conversion within the close to time period, the order charge ought to gradual as a result of difficult macros ultimately impacting backlog and income within the medium time period. Margins needs to be underneath stress as a result of destructive worth/value and up to date low-margin acquisitions within the close to time period. Nonetheless, within the medium to long run, as the corporate realizes synergy advantages and will increase aftermarket gross sales, we must always see margin enlargement. Given the blended outlook, I do not assume paying greater than the historic common P/E a number of is smart. Therefore, I choose to be on the sidelines and have a impartial score on the inventory.