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This may be the year of the tiger in the Chinese zodiac, but it’s been a year of the duck for Crane (NYSE:CR) – while things may look relatively calm at the surface level, there’s a lot of activity going on beneath the waterline. Not only has the company been navigating some challenging cross-currents in multiple businesses, as well as a still-tough supply situation, the company has pushed forward with a business reorganization and an offloading of asbestos liabilities.
It’s fair to note that Crane’s organic growth has lagged the broader industrial sector this year so far, but I do think there’s more of a “coiled spring” here heading into a more challenging 2023 than for many industrials. The shares are down about 11% since my last update, outperforming the broader industrial group a bit, but I do still see some worthwhile value here now.
Mixed Trends For Q3, But With Some Positive Points
Crane’s third quarter results were a mixed bag, but I saw more good than bad in the results, particularly as supply chain pressures ease going into 2023.
Revenue rose 2% in organic terms, and that is likely to be noticeably soft compared to the “average” industrial this quarter (of those that have reported, Dover (DOV) and Illinois Tool Works (ITW) were stronger, 3M (MMM) weaker, but obviously the business mixes are very different). Relative to expectations, Crane’s third quarter results were basically in-line (one reporting source suggests a slight beat, another a slight miss).
Gross margin improved 260bp to 40.4%, and while management said that there were still meaningful supply chain issues, the trend was improving (particularly in the Aerospace & Electronics business). Operating income fell 2% on an adjusted basis, with underlying adjusted margin up 120bp to 17.6%; segment profits fell 3% (with margin up 120bp to 20.1%), with the company seeing a hit to profits from a divestiture earlier this year.
Orders rose 10% on a core basis, with a book-to-bill of 1.1x that I think will compare favorably on a sector-wide basis coming out of this quarter. Book-to-bill was notably strong (1.3x) in the A&E business, as original equipment backlogs continue to grow ahead of broader reacceleration in aircraft construction. Overall company backlog rose 26% on a core basis.
Process Flow Should Hold Up
Crane reported 9% core growth in its Process Flow (or PF) segment, with strong trends in chemical, pharmaceutical, and general industrial markets, including MRO markets. The company also reported strong project activity, particularly with de-bottlenecking projects designed to increase capacity. Segment profits fell 9%, with margin up 130bp to 16.8%, as the business was impacted by a sizable divestiture earlier in the year.
Crane outperformed Dover pretty significantly this quarter – 9% core revenue growth and 13% core order growth versus 2% growth and a 12% booking decline at Dover – and I’ll be very curious to see what other process control companies report from here (IDEX (IEX), Flowserve (FLS), ITT (ITT), et al). I believe Crane’s business skews later-cycle than Dover, and I think that will be reflected in stronger results next year.
Still Waiting For Commercial Aircraft Builds To Really Ramp
Commercial aircraft production has been improving, but the business is still far from normalized since the pandemic. Crane reported a 1% decline in the A&E business, with commercial aftermarket sales up 16%, but with weaker results in military aftermarket, commercial original equipment, and military equipment, while core orders jumped 30%. Segment profits fell 13%, with margins down 240bp to 16.9%.
General Electric (GE) posted 25% organic revenue growth in its aviation business, with very strong aftermarket sales (up 47%) and commercial OE (up 21%) offset by weaker military (down 7%). Military is a larger part of Crane’s business, and I believe Crane is also somewhat more skewed to widebody planes; overall the comparability isn’t great (Parker-Hannifin (PH) and Honeywell (HON) are better comps), but this is what I have to work with for now, and I’d say that Crane is doing alright, particularly considering the stronger order growth (GE orders were up 6%) that suggests Crane is perhaps lagging the aerospace recovery a bit, but not missing out.
Payment & Merchandising Technologies A Microcosm Of The Larger Story
Crane’s PMT segment really reflects what I call the mixed trends at Crane, as there are parts of this business that are doing well, and others that are reporting less exciting results but not really due to a fundamental problem with the underlying business.
Segment revenue fell 3%, as the company’s Payment Innovations business saw strong mid-teens growth on healthy trends in gaming and improvements in vending, while the Currency segment saw a decline due to difficult year-ago comps. That’s the nature of the Currency business, though, as results are volatile on large and lumpy government banknote orders.
I’m a fan of the upcoming separation of Crane’s industrial businesses from PMT (which is now referred to as Crane NXT); the businesses don’t really go together and I think they’ll be better as separate entities. I’m not as convinced as some sell-side analysts seem to be that Crane NXT can transform into a disruptive technology-driven digital payments company like Worldline (OTCPK:WRDLY) or Cantaloupe, but Crane NXT does have expertise in authentication and payment acceptance, and hiring the President of Vontier’s (VNT) Gilbarco Veeder-Root as the new CEO is a reasonable move given how much of GVR’s business revolves around payment systems.
The Outlook
Between the later-cycle process flow and aerospace businesses, I think Crane is better-placed than many industrials to withstand a more noticeable short-cycle slowdown in 2023. I do worry about a further delay in greenfield flow control projects and a sharper slowdown in MRO and debottlenecking-related orders, but I think the trends in markets like pharmaceuticals are still positive. In aerospace, I’m not really concerned about the ongoing recovery in OE newbuilds.
I’m still looking for long-term revenue growth in the neighborhood of 4% from Crane, and I think the company could be more active in M&A post-split, with targets available in both flow control (and adjacent markets) and aerospace/electronics. I also still believe that low-to-mid teens FCF margins are attainable over time, helping support 6% FCF growth.
The Bottom Line
Between discounted cash flow and margin/return-driven EV/EBITDA, I believe Crane shares are undervalued today. I see a double-digit long-term annualized total return opportunity here on cash flow, while Crane’s margins and returns (ROIC, et al) should support a fair value well into the $120’s on an 11x multiple on ’23 EBITDA.
Sentiment is not strong for industrials now, particularly with fears of a sharper slowdown in 2023, and that is weighing on valuations. It will likely take some time for investors to be willing to pay up for these names again, but I do believe Crane management is making value-enhancing strategic moves and that the valuation here should be attractive for investors with longer horizons and more of a value or GARP inclination.
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