First contact does not come by hand or man, but by metal or machine. – Ryan Sean O’Reilly
Super followers of The Lead-Lag Report Twitter account would have noted my tweet where I’ve talked up the potential of the industrial sector to finish this year strongly. In fact, industrials strength is one of the sub-narratives that has been holding up the current market rally, and this is something that was discussed in more detail on Lead-Lag Live with David Nicoski recently.
The stock I’m about to cover today belongs to the buoyant industrial sector, and goes by the name of Enerpac Tools Group (NYSE:EPAC). Quite like its peers from the sector, EPAC has enjoyed a stellar month, delivering ~30% returns, almost 6x as much as what the S&P 500 delivered.
EPAC has been around for over a century and is involved in the business of selling high-precision tools and control force products, for precise heaving lifting activities (80% of business). The company also offers service and rental facilities (20% of business). EPAC’s products are sold to dealers, national level distributors, and large OEMs in more than 100-plus countries (40% of revenue is from the US).
It’s worth noting that heavy lifting activities are carried out in a plethora of end-markets which are often fragmented offering the opportunity for Enerpac to gain traction and build a name.
Here are a few additional reasons why I like this story.
We hear a lot about how cyclical companies could struggle to maintain pricing power in an increasingly recessionary environment, but that does not seem to be the case with Enerpac which was able to bring through strong pricing strength; much of the gains in the recently concluded quarter were driven by pricing increases which had a $9m impact.
Then, one of the reasons why I’m particularly excited about Enerpac is its ASCEND program, which is a transformational program that’s aimed to drive operational efficiency by utilizing a lean approach. The overall goal is to create a more agile organization. Some of the actions that they’ve recently taken include rationalizing the number of SKUs, putting in place a digital scheduling program, and improving the warehouse management system optimization.
If Enerpac can execute well, we could see EBITDA margins potentially hit the 25% levels by 2025. Put another way, you could be looking at $40-50m of incremental annualized EBITDA over the next few years. Next year alone, the company is targeting $12-18m of EBITDA benefits.
Separately, it’s worth noting that even before those EBITDA benefits come through, the stock offers good value. According to YCharts, on a forward EV/EBITDA basis, the stock currently trades at 13.6x, a discount to its five-year average of 15.1x
Don’t also discount the effect of lower supply chain and logistics related costs on the EBITDA next year.
A few days back, I had gotten into a Lead-Lag Live discussion with Craig Fuller, a freight expert, and he believes that capacity in the freight market is at all time highs and this will likely leave deep imprints on pricing, which would be beneficial for Enerpac. He also spoke about how the freight market had become even more fragmented with intermediaries and brokers taking up a greater share of freight.
Investors also should consider Enerpac’s credentials as a capital distributor. I believe it’s quite admirable that a small-cap cyclical such as Enerpac has been paying dividends for 16 straight years now!
What’s also been quite interesting to note is that the company has ramped up its desire to buy more stock. This is a company that has traditionally spent only around $25m on buybacks per year, but in the recent fiscal (August year-end) they did three times that figure. There’s plenty of scope to keep this on as they’ve currently only bought back 3.8 million shares of their ongoing 10m share buyback program announced in March.
To be so generous with your distributions, you also need the right capital structure where you’re not hamstrung by debt. Even in that regard Enerpac is very well-positioned. Around 6 years back, their net debt balance stood at $400m, now it is just a little over $125m. In effect their leverage only stands at 0.9x, well below their target range of 1.5-2.5x!
While there’s quite a bit to like about the Enerpac story, it’s worth remembering that the stock already has delivered fairly healthy returns this month and is currently not too far away from resistance levels last seen in Q2-21 from where it had reversed. Also consider that the RSI looked quite overstretched and it looks like we may be on the cusp of an RSI divergence.
Crucially, if you’ve been keeping track of my thoughts on the timeline of The Lead-Lag Report, you’d note that while I think that conditions are in place for a melt-up rally, this is still within the broader context of a broader bear market, which will also likely be reflected in the performance of long duration bonds. When real risk-off returns, small-cap cyclicals such as Enerpac could be vulnerable to a sell-off.