Reading the 10-K for 2019 from Alamo Group Inc. (ALG, Financial) is like reading an old shopping list. It features a lengthy list of industrial and agricultural machinery companies it has purchased over many years.
For example, if you see big mowers being pulled by tractors around city parks, there’s a chance the mower will have originated with an Alamo-owned company. The same holds for street sweepers, big vacuum trucks and the Gradall equipment cleaning out ditches.
If you’re driving by a farm or ranch and see agricultural mowers, tillage implements, front end loaders or snow blowers, that machinery may have come from an Alamo-owned company.
Based in Seguin, Texas, Alamo is a $1.2 billion small-cap company that has ambitions to grow.
In the 2019 letter to shareholders, President and CEO Ronald A. Robinson and Chairman Roderick R. Baty wrote, “Importantly, we feel the developments we achieved in 2019 have created a path for significant growth at both the top and bottom line for Alamo Group.”
In part, that path included the 2019 purchase of Morbark, Alamo’s largest acquisition so far, and a company that is expected to add more than 20% to overall sales. It also offers opportunities for cross-selling and better earnings thanks to achievable synergies.
It also sees organic growth and margin improvements from internal initiatives. Those included two projects in 2019, one that consolidated vacuum truck manufacturing within a newly-built facility. The second involved expansion of an existing plant.
According to the 10-K, the company also has a research and development program to address customer needs and to develop new products. Spending on R&D has been running at about 1.0% to 1.1%, allowing Alamo to employ 268 people in that function, including 152 engineers.
Some companies get into trouble with mergers and acquisitions, especially by paying too much for their targets. That does not appear to be the case for Alamo, judging by its 10-year price chart (which reflects earnings):
Gains on stock prices are the only way investors in Alamo will get a significant return. Its dividend yield is just 0.5% (or 0.51% on a forward basis). And its three-year average share buyback ratio is negative.
So what are investors, particularly value investors, to think of the company? Given that it is a Buffett-Munger stock, we will analyze it using those criteria: high predictability of revenue and earnings, a competitive advantage, little or no debt and undervalued status based on the PEG/PEPG ratio.
Predictability
Alamo earns a 4.5 out of five rating for predictability. That’s very good, and is based on its ability to consistently grow its revenue and earnings. The following chart shows 10 years of revenue per share and earnings per share information:
Competitive advantage
GuruFocus stipulates that a Buffett-Munger Screener company will have earnings strong enough to maintain or grow its margins. For Alamo, “maintain” is the key word:
In the first quarter of 2020, the gross margin grew almost a percentage point, from 24.2% to 25.1%. The improvement likely reflects gains from two major acquisitions, Dutch Power and Morbark, as well as early adverse effects from the Covid-19 crisis.
Consider, too, the many brand names in the Alamo corporate stable, each of which has loyal customers. In addition, proprietary products and features are emerging from its research and development, and it has expertise in the acquisitions field.
Debt
Alamo’s debt history looks like the path of a roller coaster:
Obviously, the debt load has increased, but has it increased too much for value investors? We get conflicting data: The company has interest coverage of 6.47, which is above the 5.00 minimum Benjamin Graham liked. It means the company’s operating income is 6.47 times greater than its interest expenses.
On the other hand, the Piotroski F-Score is low, just 3 out of 9. One of the areas for which it receives a 0 (a failing mark) is for leverage.
Finally, its return on invested capital is 8.69%, only 2.23% better than its weighted average cost of capital. That’s not much of a buffer.
Valuation
With a PEG ratio of 1.95, Alamo is considered overvalued and is seemingly at odds over its inclusion on the Buffett-Munger Screener list (PEG is price-earnings ratio divided by Ebitda growth).
But, as is often the case in this season of crises, the PEG ratio is lower than it was at the end of 2019: 2.45. What’s more, the current level is not much above the median over the past 10 years, 1.53.
We see a similar pattern when we examine the price-earnings ratio on its own, which is 18.46 and down from previous levels.
Other
Ironically, this being a Buffett-Munger Screener stock, Alamo might be the type of company that would interest Warren Buffett (Trades, Portfolio), who likes companies he can understand and products with everyday use.
The industrial and agricultural machinery that powers Alamo’s top and bottom lines is essential to the everyday infrastructure of life, whether that’s mowing parks or tilling crops.
Of course, there are few barriers to entry and lots of competition in supplying those products, but Alamo does have the management to keep growing its market share in these industries.
Conclusion
Alamo Group is not a “pure” Buffett-Munger Screener stock. While it has strong predictability and reasonable competitive advantages, it also has a moderate amount of leverage and there is no margin of safety.
For investors seeking a small-cap presence, this company is worth further consideration, given its power to grow its revenue and earnings. And it sells semi-essential products that are in constant demand.
Value investors, on the other hand, will likely look elsewhere. Buying without a margin of safety, especially a small-cap stock, means there is no margin for error or for external forces like the one we are now living through.
Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.
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