Regal Rexnord Makes A Big Play For Scale And Diversification (NYSE:RRX)

Considering the disruptions created by the pandemic, it’s challenging to evaluate the performance of Regal Rexnord (NYSE:RRX) since the transformative combination of Regal Beloit and Rexnord’s PMC business in early 2021. Still, the company has more or less stayed on track relative to my initial financial expectations, and the shares had been modestly outperforming the average industrial since my last update.

Now, Regal Rexnord management is taking another big swing at scale, diversification, and growth, announcing an all-cash acquisition of Altra Industrial Motion (AIMC) for $62/share. These businesses should be highly complementary, and I like the opportunities for cross-selling and expense synergy, as well as diversification. While the combined businesses will still have significant short-cycle leverage, not the best thing for the environment I expect in 2023-2024, I like the added exposure to automation and medical markets.

Another Transformative Deal

Regal Rexnord’s bid for Altra is another aggressive move to add scale and complementary products, as well as accelerate the company’s plans to move its mix toward higher-growth markets like life sciences and automation. Regal Rexnord is offering $62/share in cash, a 55% premium to the share price prior to the announcement, and a roughly 12.75x multiple of my FY’22 EBITDA estimate. Given the recent challenges to margins from higher input and operating costs, it’s a reasonable premium for both parties.

Altra brings a highly complementary portfolio of power transmission and motor control products, including leading businesses in clutches, brakes, gearing, and couplings used in a range of industrial applications like conveyor systems, elevators, and off-road mobile equipment (trucks, tractors, etc.). These products will fit in well with Regal Rexnord’s Motion Control gearings, bearings, couplings, and related products, and will further Regal Rexnord’s single-source advantages. As the only player that can offer a complete industrial powertrain solution, Regal Rexnord can offer “one-stop shopping” to customers, as well as the added convenience of components that are designed to work together.

Altra also brings its automation and specialty motion control operations to Regal Rexnord. Through brands like Kollmorgen and Thomson, Altra sells a range of precision motors, actuators, servos, and other motion control products that are used in attractive end-markets like aerospace, industrial automation, and medical devices (including motors that power surgical robot arms and cobots).

Near-Term Challenges

Even with the diversification that the deal offers, the new Regal Rexnord will still generate around 20% of its revenue from short-cycle industrial end-markets, and short-cycle demand is starting to taper off in response to higher interest rates and lower confidence about conditions in 2023. On top of that, markets like factory and warehouse automation, off-road vehicles, HVAC, and mining are likely to slow (if not decline) in 2023 as well. I don’t expect the automation weakness to last long, but major automation adopters like Amazon (AMZN) are now in a period of “digesting” prior system investments.

Regal Rexnord will also have to execute on cost synergy opportunities. The company’s track record here has been more mixed over recent years, as the company has had challenges adjusting its high fixed asset intensity and improving upon fairly run-of-the-mill gross and operating margins. Given the complementary nature of the businesses, I do think that management’s target of $160M in cost synergies (around 2.5% of the combined expense base) is credible, but there will be a “show me” aspect to this story for at least a couple of years.

The Outlook

I expect the new Regal Rexnord to leverage the higher-growth end-market exposures of Altra to generate longer-term revenue growth ahead of underlying GDP and industrial production growth. My modeling estimates work out to a long-term organic growth rate of around 4%, mid-20%’s EBITDA margins in around three years, and long-term FCF margins in the mid-teens, with some upside if the company can outperform on paring away lower-margin business and/or gain share in faster-growing, higher-margin end-markets like aerospace, automation, and life sciences.

The Bottom Line

Regal Rexnord shares look undervalued to me, but then so do the shares of many companies with significant short-cycle industrial exposure. The market is very nervous about 2023 right now, which is understandable given what’s going on with interest rates and business confidence and a coming fall in indicators like PMI. I do see some risk of further negative revisions to the 2023/2024 outlook, and analysts often cut too deeply on cyclical swings (forgetting that there will be a cyclical upturn as well). So while I do think that Regal Rexnord shares offer attractive long-term upside from here, investors should appreciate there could be some near-term risk to the share price as the market dials in its expectations for the cyclical downturn.