nVent Stock: Expects Margin Expansion In 2023; May Imply Undervaluation

nVent Electric plc (NYSE:NVT) reported an impressive quarter, and announced further sales growth and margin expansion in 2023. Considering the recent accumulation of cash and the company’s expertise in the M&A markets, I would expect more inorganic growth. Under my own cash flow model, with conservative financial figures, I obtained a valuation of $59 per share, which is larger than the price of NVT stock right now.

nVent Electric

nVent Electric plc presents itself as a leading global provider of electrical connection and protection solutions. The company designs, markets, and installs high performance products and solutions that connect some of the most sensitive equipment, buildings, and critical processes in the world.

With the presentations being done, I would like to go straight to the point. I believe that the most recent quarterly report will likely impress most market participants. The company delivered record sales of $2.9 billion, operating margin expansion, and impressive cash flow generation.

For the full year, we had impressive growth and strong execution resulting in record sales of $2.9 billion, margin expansion and robust cash flow. Source: Quarterly Report

Among the explanations given in the quarterly report, I would note the new products announced and successful digital transformation, which may be driving demand for nVent’s solutions.

We launched 59 new products, focused on high-growth verticals, advanced our digital transformation, and our acquisition sales growth exceeded overall nVent growth. The electrification of everything, sustainability, and digitalization are driving demand for our products and solutions. Source: Quarterly Report

Finally, considering the expectations about 2023 given by management, I decided to run my own financial model. My results indicated that nVent Electric could be trading at much more than its current market price.

Our portfolio today is stronger and well positioned for sales growth and margin expansion in 2023. Our future is bright at nVent. Source: Quarterly Report

nVent’S Climate Change And Sustainability Strategy Could Bring New Investors

I studied the company’s efforts with regards to sustainability matters and targets related to environmental impact. In my view, considering the importance of ESG matters, in the future, nVent could receive significant stock demand as soon as more investors learn about the company’s targets.

In addition, as part of our strategy regarding climate change and sustainability matters, we have set and may set additional targets aimed at reducing our impact on the environment and climate change and/or targets relating to other sustainability matters. Source: 10-k

In addition, investors and other stakeholders are increasingly focused on environmental, social and governance (“ESG”) matters. Source: 10-K

Assets, Acquisitions, And Assessment Of Intangibles

The recent increase in the amount of cash is quite impressive. Cash on hand increased from $49 million in 2021 to $297.5 million in 2022. Accounts receivable stood at $472.5 million with inventories of $346.7 million and total current assets of $1,229.2 million. Total current assets are close to 2x total amount of current liabilities, so I believe that liquidity does seem quite substantial.

Property, plant and equipment stood at $289.2 million with goodwill worth $2.178 billion, intangibles of $1,066.1 million, and other non-current assets of $139.6 million. Finally, total assets are equal to $4.902 billion, close to 1.8x the total amount of liabilities.

Considering the amount of goodwill reported, it is worth noting that management is quite experienced in the M&A markets, which most market participants will likely appreciate. The company went through many acquisitions, separations, and other transactions. nVent Electric continues to acquire new targets mainly in the Enclosures segment. Some of the companies bought recently are mentioned below.

On February 10, 2020, we acquired substantially all of the assets of WBT LLC 10-K

On April 1, 2021, we acquired substantially all of the assets of Vynckier Enclosure Systems, Inc.

On June 30, 2021, we acquired CIS Global LLC (“CIS Global”). Source: 10-K

With regards to the type of intangible assets reported, I believe that it is worth mentioning that most intangible assets are represented by customer relationships. Trade names and patents don’t seem to be that relevant for the company. In my view, it is good that investors understand that the company buys out other targets for customer acquisition, not that much for the technological capabilities of competitors. The following table is taken from a recent quarterly report.

Liabilities

Among the liabilities, I found current maturities of long term debt of $15 million, accounts payable of $252.1 million, and employee compensation and benefits of $109.3 million. Other current liabilities stood at $273.1 million, and total current liabilities were equal to $649.5 million.

Long term debt stood at $1.068.2 billion with the pension and other post-retirement benefits of $128.5 million. Besides, deferred tax liabilities were around $199.6 million with other non-current liabilities of $124.7 million. Finally, the total liabilities were equal to $2.17 billion.

Recent Quarterly Income Statement And My Expectations Until 2026

The quarter ended December 31, 2022 was quite impressive. The company reported net sales of $741.6 million along with a cost of goods sold of $450 million. The gross profit stood at $291.6 million, which represented close to 39.3% of total quarterly sales. Let’s keep in mind that the gross profit margin increased by 2.3% as compared to the figures reported in the same quarter in 2021.

SG&A expenses stood at $150.7 million with research and development being around $15.8 million. Operating income was equal to $125.1 million, which means an operating margin close to 16.9%. Let’s note that the operating margin also increased as compared to the same quarter in 2021. The income before income taxes was $182.4 million. Finally, net income for the quarter increased from $67 million in 2021 to $158 million in 2022.

The expected results for 2026 include net sales of $3.475 million, which will present a conservative net sales growth of 4.70%. In addition to the cost of goods sold of $2.165 billion, research and development expenses of -$72 million, and net interest expense of -$37 million, I assumed 2026 net income of $511 million. I believe that my figures are not far from the expectations of other market analysts.

My cash flow model would include 2026 net income of $511 million, depreciation of $52 million, and amortization of $84 million. The deferred income taxes would be -$16.2 million with a shared based compensation of $29.9 million, pension and other post-retirement expenses of -$73.3 million, and pension and other post-retirement contributions worth around -$6.6 million.

With changes in accounts and notes receivable of -$54.8 million and changes in inventories of -$41.5 million, I also included changes in accounts payable of -$5.6 million. Finally, with employee compensation worth -$2.5 million, I obtained 2026 CFO close to $505 million.

With net cash provided by operating activities of $505 million and 2026 capex of -$58 million, 2026 FCF would stand at $447 million. Besides, the net present value of future FCF would be $1.262 billion.

Valuation

According to YCharts, the company traded at much more than its current EV/EBIT ratio. I believe that assuming a valuation close to 22x EBIT could make sense. I also think that the recent increase in the company’s operating margin will likely have an effect on the company’s EV/EBIT ratio.

The expected EBIT for 2026 would be $560 million with an EV/EBIT of 24x. The final value will be around $13 billion with a NPV of $9.4 billion. I assumed a WACC of close to 9%, which is close to what other analysts are using.

Considering cash of $297 million, debt, and post-retirement benefits close to $1.2 billion, the implied fair price would stand at close to $59 per share.

Risks From Merger Integrations, Failure Of Finding New M&A Targets, And Debt Covenants

Considering the total amount of goodwill accumulated, goodwill impairments could occur. Besides, if the company fails to successfully integrate the new companies acquired, synergies realized could be lower than expected. As a result, I believe that future FCF growth could diminish. In sum, the fair price could be lower than what I calculated.

Besides, I believe that debt investors may also stop some of the acquisitions proposed by management. Let’s keep in mind that management signed several debt covenants, which may retract the number of options. In my view, future sales growth and recent increase in operating margins would help explain new transactions. However, investors need to know about these agreements with debt holders.

Our credit agreements and indentures contain customary financial covenants, including those that limit the amount of our debt, which may restrict the operations of our business and our ability to incur additional debt to finance acquisitions. Our ability to meet the financial covenants can be affected by events beyond our control, and we cannot provide assurance that we will meet those tests. A breach of any of these covenants could result in a default under our credit agreements or indentures. Source: 10-K

The company may also have difficulties in finding new acquisitions at decent valuations. As a result, I believe that inorganic growth would most likely decline, which may lead to lower EBIT expectations.

I am also a bit concerned about the fact that the company was incorporated in Ireland, where securities laws could differ from those in the United States. Management made several commentaries in this regard:

It may not be possible to enforce court judgments obtained in the U.S. against us in Ireland based on the civil liability provisions of the U.S. federal or state securities laws. In addition, there is some uncertainty as to whether the courts of Ireland would recognize or enforce judgments of U.S. courts obtained against us or our directors or officers based on the civil liabilities provisions of the U.S. federal or state securities laws or hear actions against us or those persons based on those laws. Source: 10-K

Conclusion

nVent Electric reported an impressive quarter, and announced that it is well positioned for sales growth and margin expansion in 2023. In my view, if the cash accumulated is used for further design of products and more acquisitions, I would expect further revenue growth and FCF generation. Under my own financial model, with conservative financial figures, I obtained a valuation of $59 per share.