Brady Has An Opportunity To Be More Than It Has Been, But Execution Is Uncertain (BRC)

Can Brady (NYSE:BRC) be more than it has been?

This company hasn’t exactly covered itself in glory on a long-term basis. Despite rather strong margins and ROIC, the company hasn’t really been able to find growth – since 2000 revenue has grown at an annualized rate of 4%, while EBTIDA has grown about 4.6%. Adjusted free cash flow has done better (up around 7.5%), but the stock performance tells the tale – the shares have lagged the market and the industrial sector on an extended basis, with a 10-year annualized return around 6%.

That’s not an inspiring backdrop, but the company has been actively cutting costs and streamlining its portfolio, and management seems to appreciate the need to find growth opportunities and is targeting some logical areas that I think could hold some promise. I can’t say I love this company, but if it can deliver on what I think are pretty low expectations, I can definitely see upside from here.

Mixed FQ1 Results, But There Were Definitely Some Positives

Brady’s fiscal first quarter results were definitely mixed, with revenue growth that was a little weaker than expected and weaker than the typical industrial, but with some decent relative outperformance within its sub-sector and some better-than-expected operating leverage.

Revenue rose 7% in organic terms, below the roughly 11% to 13% average range this quarter for industrials, and a little below expectations, but not bad next to Honeywell’s (HON) Productivity Solutions (up 2%) or Zebra (ZBRA) (down 3%). Management didn’t specify the price/margin mix, but I’m thinking the company saw mid-single-digit price leverage this quarter (500bp-700bp) and some volume growth (0bp to 200bp). By business segment, Identification Solutions revenue rose almost 9%, while Workplace Safety was up about 1%, and I suspect there was better volume growth in ID Solutions.

Gross margin declined 10bp sequentially, but at 48.1% isn’t too bad relative to pre-pandemic levels despite the inflation in materials and freight costs. Operating income rose 16%, with margin up 190bp to 15.9%, and the company did outperform here on tighter opex spending. Segment profits rose 13% (margin up 210bp to 18%), with ID Solutions up 5.5% (margin up 50bp to 20.1%) and Workplace Safety up 178% (margin up 650bp to 9.6%).

Workplace Safety Efforts Definitely Bearing Fruit

Workplace Safety has been struggling as a unit for some time now. Part of the problem is that the company’s products aren’t particularly well-differentiated and historically around half of sales come from products resold under private labels. At the same time, rivals like Avery Dennison (AVY), CCL Industries (CCL.A:CA), Johnson Controls (JCI), 3M (MMM), Newell (NWL), and Zebra have been chipping away at the business, leading to share loss.

Management has been addressing this more directly in recent quarters – actively streamlining the portfolio and pruning away products that don’t earn worthwhile margins. While I wouldn’t call Workplace Safety a great business now, there has nevertheless been meaningful improvement.

I think proper expectations are important here. I don’t ever see this business being a real contributor to growth, and I don’t expect the company to find a worthwhile transaction for the business. Instead, I expect management to maximize the value here and harvest it for cash.

Identification Solutions Needs More Work, But Holds More Promise

Brady’s Identification Solutions business is basically in the business of equipment, disposables, and software for scanning, labeling, and tracking objects and people. If you’ve ever gotten a printed wristband at a healthcare appointment or at a concert, that’s one part of the business. Other parts include more traditional bar code and RFID labeling/printing/scanning for industrial and retail goods.

I believe Brady has historically been too focused on scale and margin and not focused enough on strategic growth – past acquisitions brought in size, but not much in the way of new strategic opportunities, and I think the company has been slow to appreciate follow-on offerings. Given the core addressable markets, for instance, Brady arguably should have been at the forefront of IoT and IoT-enabled asset tracking. As is, the company has seen new approaches like QR codes start to impact the business.

I don’t think the business is fundamentally hamstrung, though, and management seems to be thinking at least a bit outside the box in terms of growth opportunities. The biggest of these opportunities is a collection of “track and trace” opportunities using in-field performance labels in markets like agriculture, aerospace, construction, mining, oil and gas, where tracking assets can be vital to running complex tasks efficiently. Longer term, I also see opportunities like real-time sample tracking (within labs) and patient tracking as opportunities worth exploring – long-term care facilities in particular have a strong interest in making sure they know where residents are at all times.

In the near term, I do see some risks from the weaker conditions I expect for many short-cycle industries in 2023. As ID/tracking does tend to be driven by volume (economic activity), a slowdown is a threat.

The Outlook

With forex still taking a toll, I expect relatively minimal growth this year (around 1.5%). Moreover, given the likely lackluster top-line results in store from Workplace Safety and valid questions about the growth of the Identification Solutions business long term (the potential is there, but the willingness to invest may not be), I think 2% to 3% is a reasonable expectation for long-term growth.

Looking at margins, the company has been pretty consistent over time, generating low-to-mid-teens EBITDA margins and a weighted-average FCF margin of 9.3% between 2001 and 2011 and 9.4% between 2012 and 2022. There has been a recent uptick, though, and I do think high-teens EBITDA margins are sustainable, with maybe 20% attainable in around five years. Likewise with FCF margin – I could see the company holding on to low-to-mid-teens margins from here on, driving double-digit reported annualized FCF growth and normalized growth in the mid-single-digits.

Discounted cash flow suggests a potential annualized return in the high single-digits (around 8%). Using the margins and returns (ROIC, etc.) that I expect from the company over the next couple of years, I believe 11.5x is a fair forward EBITDA multiple, and that gives me a fair value of $53 today.

The Bottom Line

There are certainly things about Brady that many readers won’t like – the relatively weak long-term growth history, the dual share structure that gives the founding family total voting control, and a history of underinvestment (at least in my opinion) of technology-driven follow-on offerings that could have leveraged the business base established by the traditional barcode/RFID labeling business. Still, there’s more value than I expected to find, and if management gets serious about reinvesting in the business and leveraging technology-driven solutions, the company could start to reverse its history of underwhelming relative performance.