Bottom fishing is a highly prevalent activity among traders as well as investors after the market crash. This is particularly common with respect to sectors like industrials, automobiles and consumer discretionary sectors, which are bound to remain slow for the coming few months and pick up a few quarters after the lockdown is lifted.
However, it is a common mistake to identify companies that are exceptionally cheap and invest in them without realizing that there is actually a very strong fundamental reason why they are trading at such low valuations. In my opinion, thermal management solutions provider Modine Manufacturing (MOD, Financial) is a classic example of a stock where investors can make such a mistake.
What does Modine Manufacturing do?
Modine Manufacturing Company is one of the oldest companies in the field of thermal management solutions in the U.S. Founded in 1916, the Wisconsin-based engineering firm provides heat transfer systems, radiators, condensers, coolers, radiator cores, HVAC systems, coils and different forms of ventilators for vehicular, commercial and industrial application. Its clients include a large number of Original Equipment Manufacturers (OEMs) such as automobile, truck, bus and specialty vehicle OEMs, agricultural, industrial and construction equipment OEMs, commercial and industrial equipment OEMs, HVAC OEMs, construction architects, contractors and wholesalers of heating equipment. Its products are in demand all over the world, and it has operations in LATAM, Europe, Asia-Pacific, MENA and the U.S.
Bad results and the stock price crash
Modine has been delivering bad results for many quarters well before the Covid-19 crisis. This is the reason why the stock has lost around 71% of its value in the past 12 months.
In its most recent quarterly results, the company missed analyst estimates on the revenue front but managed to deliver an earnings beat. The company reported a top-line of $473.4 million for the quarter ended Dec. 31, 2019, which was a $67.6 million drop as compared to the corresponding quarter of the previous year and came in below the analyst estimates of $474.56. Earnings were slightly better, as the company reported earnings per share (EPS) of 37 cents, which were above the analyst consensus estimate of 20 cents per share.
It is worth highlighting that Modine has not beaten or even matched analyst expectations on the revenue front for the past four quarters. The management had reported weakened guidance even before the pandemic started spreading.
Struggle in divesting the automotive business
Modine operates through three segments: Vehicular Thermal Solutions (VTS), Commercial and Industrial Solutions (CIS) and Building HVAC (BHVAC). The BHVAC business seems to be the only strong segment, with double-digit growth as well as good profitability, but the VTS and the CIS businesses have underperformed significantly. These segments experienced larger than expected declines in customer orders that negatively impacted the outlook for Modine’s revenues and earnings.
The automotive segment, which is the biggest among the company’s segments, has been in the process of being divested by the company. The company entered into a formal sale process in the summer of 2019, but the challenging business environment caused the sale to be delayed. Modine had received bids from both strategic and financial buyers earlier in 2019 but failed to reach an agreement with one of the shortlisted buyers, which might prove to be a costly decision now. The management originally planned to re-invest the proceeds from this business sale into the company’s outperforming BHVAC segment.
Cost-cutting Initiatives
Modine’s management has been acting on the fixed costs of the company to ensure that the net margin and shareholder value creation remain strongly positive. CEO Thomas A. Burke and his team have implemented a number of aggressive cost-containment measures to achieve both short-term cost savings and long-term optimization of resources.
These measures involve reducing operational expenses and Selling, General and Administrative (SGA) expenses, which will be executed through faster procurement, structural changes in the organization and some retrenchments in order to optimize costs. The management expects these initiatives to deliver between $25 million and $30 million in annual cost savings over the coming year.
Key takeaways
Modine’s valuation multiples are very low. The company is trading at an enterprise-value-to-revenue multiple of 0.31 and a price-sales of 0.11, which are among the lowest in the automobile and parts industries. However, apart from the impact of Covid-19, the inability to divest the automotive segment is also a major cause of concern. Despite its low valuation, I believe the company has a bleak outlook and should be avoided.
Disclosure: No positions.
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