Aero Continues To Accelerate For Crane (NYSE:CR)

It’s early in the reporting cycle for industrial companies, but so far, it would seem that short-cycle industrial is holding up better than expected going into 2023. Industrial distributors Fastenal (FAST) and MSC Industrial (MSM) both did a little better than expected and in the mess that was fourth quarter earnings for 3M (MMM), the core industrial business was ahead of expectations, as was the Machining and Manufacturing Solutions business at Sandvik (OTCPK:SDVKY).

The comparability of these businesses to Crane (NYSE:CR) is admittedly limited, but the point stands that short-cycle is holding up a little better than expected, even though orders are shrinking and most industry participants (Crane included) expect deceleration from here. At the same time, aerospace continues to ramp, and Crane Payment Innovations (CPI) is looking well-placed for 2023.

These shares are up about 20% since my last write-up, handling beating the S&P 500 and industrial space since then. Not much changes about my expectations or outlook for the business; I remain bullish on Aerospace & Electronics (or A&E) in the near term, while I think Process Flow will skew a little more longer-cycle than many process control companies. With Crane set to grow long-term at around 4% and 6% for revenue and free cash flow, respectively, I think this is an okay hold today.

Fourth Quarter Results Underlined By Healthy Margins

Crane’s beat relative to the Street wasn’t so impressive on the top line, but margins came through nicely, with no real areas of weakness.

Revenue was flat as reported but up about 11% in organic terms, coming in just above sell-side expectations. Growth was led by the Aerospace & Electronics (up 15%) and Payment and Merchandising Technologies (or PMT) segment (up 14%), while 8% growth at Process Flow was solid as well. Relative to expectations, Process Flow beat by almost 5% and A&E by about 2%, while PMT missed by about 4%.

Gross margin improved 460bp yoy and 40bp qoq to 40.8%, helping drive adjusted operating income growth of 54% and a very solid 10% beat versus the Street, with margin up 660bp yoy and 100bp qoq to 18.6%. At the segment level, profits rose 25%, with margin up 390bp to 19.5%.

Process Flow saw a 5% decline in adjusted profits (with margin up 180bp to 16.1%), matching expectations at the margin line. PMT profits jumped 51%, with margin up 740bp to 25.9%, beating by 380bp. A&E profits rose 81%, with margin up 750bp to 20.6%, beating by 180bp. Margins for the small Engineered Materials business were also better than expected, but this business doesn’t really move the needle for reported results all that much.

A Sign Of Things To Come?

As I said in the open, there’s really not much benchmarking to be done at this point, as so few comparable companies have reported yet.

That said, surveys of fluid power distributors have shown demand holding up better than expected, and there is some later-cycle leverage in Process Flow to areas like chemicals, oil/gas, power, and pharmaceuticals that is likely to hold up better than “general industrial” and construction markets. Core orders rose 9%, and while management expects the segment to weaken as the year goes on, initial guidance is for 4% growth that is in line with long-term expectations for the business.

In the A&E business, 15% growth was apportioned to 11% growth in the commercial original equipment business and 25% growth in aftermarket, with core orders up 45%. General Electric (GE) did even better, with 26% revenue growth (including 30% OE growth and 28% aftermarket growth), but Crane management did mention some ongoing supply constraints. Management’s initial guide of 10% revenue growth for 2023 seems conservative if anything, particularly given underlying momentum in the market.

PMT saw 12% core order growth and management is expecting around 3% overall growth, with Currency likely to be flat and CPI growing 5%. The CPI number makes sense in the context of ongoing investments in payment systems and healthy activity in gaming, and ongoing returns to office work should help vending. On the Currency side, management is taking what looks like a conservative guide given uncertainties around banknote orders from the U.S. government.

All told, this was a marginally better set of results than I expected, and it is modestly encouraging for the broader industrial space – particularly with others like 3M and Sandvik seeing still-healthy near-term short-cycle demand (while also seeing lower orders and growing evidence of weakness in the end markets).

The Outlook

Management will hold an investor day on March 9 for both Crane and Crane NXT ahead of the start of when-issued trading in mid-to-late March and the eventual final separation of Crane NXT (the PMT business) from the company. I continue to believe that this separation makes sense given the very different natures of the two businesses.

A key consideration with Crane NXT remains how the market will view this company – is it a “payment tech” company like management would like analysts and investors to believe, or is it more of a legacy specialty/niche industrial? I believe it’s more the latter, but there’s an opportunity here for management to sell the Street on the idea that it’s more of a tech-driven business than commonly perceived.

Looking at the consolidated business, not a lot changes in my model – my revenue numbers for FY’23 and FY’24 are a little lower, but my margin estimates are a little higher and it doesn’t shift valuation around that much. I’m still looking for long-term revenue growth of around 4% and free cash flow growth of around 6%. I continue to believe that the shares are undervalued by both discounted free cash flow and margin/return-driven EV/EBITDA. The former suggests a high-single digit long-term annualized potential total return, while an 11x multiple on my ’23 EBITDA number supports a fair value in the $130s.

The Bottom Line

With the recent outperformance, I don’t like Crane quite as much as I used to, though I still think it’s a solid hold. I like Crane’s leverage to aerospace and some of the later-cycle aspects of the Process Flow business, and I believe aero-heavy industrials can continue to outperform for a little while longer. Were Crane to pull back without a clear reason, it’s a name I’d definitely consider again, and even as is, it’s very close to a “Buy” for me.