niphon
Investment Thesis
CIRCOR International, Inc. (NYSE:CIR) recorded a healthy sales volume and improved orders from its Aerospace & Defence segment in Q2 2022. The Industrial segment’s revenue grew 5% year-over-year organically, though its orders were 11% less than the prior year due to a large Navy order in the prior year and the Pipeline Engineering exit. Nevertheless, new business activities in China and a strong pipeline of projects in this segment should help the company improve its revenue growth rate in the upcoming years.
The company’s value-based pricing, simplification, and best-cost country initiatives are contributing to margin improvement. Some of the initiatives are in their early stages, and proper implementation of them should help the company to offset the cost inflation in future years.
The company is trading at a discount to its historical level, making it a decent buy for a medium to long-term investment.
Last Quarter Earnings
-
CIRCOR reported its Q2 2022 results late last month.
-
In Q2 2022, CIRCOR’s revenue stood at $191 million, which was 8% Y/Y organic growth.
-
Overall orders for this quarter were 1% lower than the previous year but were up 5% Y/Y organically.
-
The organic revenue growth of the aerospace and defence segment was 15% year on year while the organic growth of the industrial segment increased by 5% Y/Y.
-
The adjusted earnings per share were $0.32, which was a substantial increase of 60% year-over-year.
-
Strong execution across the business led to an adjusted operating margin of 8.7%, which was an increase of 280bps from the prior year.
CIRCOR Revenue Outlook
With the increased demand in the market for its products and services, the company generated 8% organic growth in its revenue year-over-year. Let us see, in detail, the major factors that affected the company’s revenue in the past few years.
Impact of COVID-19
During the initial phases of COVID-19, CIRCOR was adversely affected due to the restrictions imposed during the lockdown. However, as restrictions in the commercial aerospace and industrial sectors loosen, increased demand for CIRCOR’s products and services can be seen from the last few quarters.
Government spending on spare parts in the defence sector was also initially impacted by COVID-19, which is now offset by US government defence programmes such as Joint Strike Fighter and Columbia class submarines.
Impact of supply chain constraints
The global supply chain constraints and disruptions were the headwinds to the revenue growth rate in the second quarter of 2022. These disruptions are estimated to have cost the company $6 million in revenue in this quarter as the conversion of sales to backlog was delayed. This also resulted in a 9% Y/Y increase in the total backlog of CIRCOR. The robust backlog in both the segments (up 4% Y/Y in A&D and up 12% Y/Y in Industrial) indicates an opportunity for the company because when the global supply chain disruptions ease, the company’s backlog to sales conversion rate will also improve, which should increase the revenue growth rate in upcoming years.
A&D (Aerospace and Defence) segment
In the second quarter of 2022, defence orders grew by 37%, driven by orders for the Columbia submarine, aircraft carrier, and fighter jet. The organic order in commercial aviation grew by 50%, driven by the Airbus A220 and Boeing 737 platforms. Such a significant increase in the orders for its products and services indicates strong demand in that sector, which will result in increased revenue for CIRCOR in the coming years.
Industrial and downstream markets segments
While demand remained robust in the industrial aftermarket and downstream segments, the overall organic order growth rate was down by 4% year-over-year. This happened due to approximately 10 percentage points of headwind from the timing of a large Navy order booked in the prior year and 3 percentage points of headwind from exiting the Pipeline Engineering business.
But these issues were partly offset by organic growth across the industrial end market, which saw the second consecutive quarter of mid-20s growth while there was a 17% growth in the downstream segment.
For the future outlook, I believe an increase in the number of orders from new business activities in China for lithium battery manufacturing coupled with a strong pipeline of industrial projects in North America, India, and the Middle East should contribute to improving revenue in the next few years.
New areas of growth
In line with its growth strategy, the company has taken advantage of two growth opportunities by leveraging its core technologies and manufacturing capabilities in new and adjacent markets.
First is the fast-growing hydrogen market where the company introduced two critical products, which are balanced isolation value and dome regulators. From their launch in late 2021 till date, the management has been able to capture over $8 million in orders from these products.
The second is in the medical sector, where the company has generated $24 million in orders year-to-date through its design and manufacturing capabilities.
Looking forward, I believe the company should generate an increased number of orders from both sectors in upcoming years, leading to an improved revenue growth rate.
Pricing strategy
CIRCOR has also taken advantage of its value-based pricing initiative. The management has strong insight into the needs of the company’s current and prospective customers, which enables them to escalate prices through new and technologically advanced products. This can be seen in a 100 bps improvement in price in the A&D segment and a 330 bps improvement in the industrial segment. The initiative of value-based pricing should continue to offset inflation and drive an improved revenue growth rate in the future.
Looking ahead, I believe that continued robust demand from its A&D segment as well as improved prospects for the Industrial segment, coupled with its value-based pricing initiative to offset the inflation and strong backlog, should help the company to improve its revenue growth rate in the upcoming years.
Margin Outlook
The adjusted operating margin for the second quarter of 2022 stood at 8.7%, a substantial increase of 280 bps year-over-year. This improvement was due to the company’s initiative of Margin Expansion, which is driving three key areas: value-based pricing, simplification, and best-cost country manufacturing.
Value-based pricing
The value-based pricing, explained earlier in the article, is helping the company to escalate the pricing for its products and services, which is leading to a positive cost/price relationship in its business to drive an improved margin growth rate. The company has now implemented this initiative in its industrial segment, and with its implementation in the second quarter of 2022, the company has generated an increased adjusted operating margin of 110 bps year-over-year.
Simplification
Through a simplification initiative, the company is evaluating its cost structure and identifying opportunities that reduce its overhead costs. These initiatives resulted in a structural cost reduction in the first half of 2022 of about $12 million on an annualised basis, and the company has already identified additional opportunities for future implementation, which should likely reduce operating expenses as a percentage of sales in the future.
Best-cost country manufacturing
CIRCOR continues to drive sourcing activities from low-cost countries and increase capacity from its manufacturing sites in Morocco, India, and China. This initiative is in its early stages and when it is fully implemented, it should increase productivity at a lower cost, which should improve the margin growth rate.
Headwinds Receding
Like most of the other industrial companies, CIRCOR is also facing major headwinds to margin from supply chain challenges, the inflationary environment and labour shortages.
The supply chain challenges are mostly in Europe and are driven by suppliers’ longer lead times as well as some logistical impacts for which the management is evaluating and increasing the number of suppliers from which raw materials are procured. While I believe these disruptions will last a few more quarters before eventually stabilising, we should see sequential improvement over the coming quarters. The labour shortage, on the other hand, was mostly focused on the sites in New York and California, which are now showing improvement as per management.
Looking ahead, I believe that the company’s pricing, simplification, and best-cost country initiatives should offset future cost inflation, and the eventual easing of the supply chain and inflationary headwinds should help in the expansion of the margins of the company.
Valuation
If we look at current consensus estimates, CIRCOR is trading at 15.21x FY22e EPS of $1.21 and 13.61x FY23e EPS of $1.40. This is a discount to its average 5-year average P/E (forward) of 17.21x. After looking at the valuation and CIRCOR’s growth prospects, I believe the company is undervalued and provides a decent buying opportunity for mid to long-term investors.
Be the first to comment