By John F. Hingher, CFA We at Standard & Poor's Equity Research Services think the shares of electrical and mechanical products outfit Regal-Beloit (RBC
; recent price, $29) are undervalued, based on our view that the company is in the early stages of a cyclical recovery in many of its end markets. Other positives for the stock, in our opinion: Management's extensive efforts to lower manufacturing costs -- which we think will begin to bear fruit in the form of improving margins -- and the diversity of the company's end markets.
We also believe the recent acquisition of General Electric's (GE) HVAC and refrigeration motors and capacitors operation will significantly add to 2005 earnings per share (EPS). We have assigned Standard & Poor's highest investment ranking, 5 STARS (strong buy), to Regal-Beloit's shares.
BRIGHT SPARKS. The company was founded in 1955 as a manufacturer of high-speed cutting tools. After numerous acquisitions, as well as internal growth, the outfit has become a prominent maker and worldwide supplier of electrical products (such as motors and generators) and a diversified line of mechanical products to control motion and torque. Regal-Beloit entered the industrial electric-motor and electric-power generation markets in 1997 to leverage its core competencies in industrial manufacturing and diversify from its existing mechanical businesses.
Regal-Beloit's electrical group (71% of 2003 net sales, up from 69% in 2002) makes and markets AC and DC industrial electric motors. The company offers about 5,500 stock models, in addition to motors produced to specific customer specifications. It estimates the market for electric motors tops $24 billion worldwide, and is overall about $9 billion domestically.
The company currently competes primarily in the $2.3 billion industrial sector of the larger domestic electric-motor market. Within this arena, Regal-Beloit vies against numerous businesses that are divisions of larger companies and ranks second in domestic market share behind Baldor Electric (BEZ
; not ranked; $28) and ahead of Emerson Electric (EMR
; 3 STARS, hold; $70), Rockwell Automation (ROK
; 3 STARS; $49), and Cummins (CMI
; 3 STARS; $84).
Major foreign competitors include Siemens (SI
; 1 STARS, strong sell; $84), Toshiba, Leroy-Somer, and ABB (ABB
; not ranked; $5.60).
TOUGH TORQUE. The electrical group also produces and sells electric-power generation components and controls, along with electrical-connecting devices. Regal-Beloit believes it is the largest maker of electric generators in the U.S. that is not affiliated with a diesel-engine manufacturer.
The segment's products are sold to distributors, original equipment manufacturers, and end users across many markets, including power transmission, pump, food processing, fitness equipment, industrial machinery, compressors, elevator and machine tools, agriculture products, construction, and refrigeration.
Regal-Beloit's mechanical group (29% of 2003 net sales, versus 31% in 2002) produces a wide variety of motion control products and cutting tools. Gear and transmission -related products primarily control motion by transmitting power from a source (such as a motor or engine) to an end use (such as a conveyor belt), usually reducing speed and increasing torque in the process.
ONE OF EACH. Major competitors include divisions of Colfax Corp., Rockwell Automation, Emerson Electric, and Peerless-Winsmith. The business sells to a diverse set of end markets, including industrial machinery, construction, agriculture, material handling, oil, gas, food processing, healthcare, packaging, and water distribution.
We believe Regal-Beloit should be able to grow revenues from existing businesses at a rate above the markets in which it competes. We expect its superior internal growth to be powered by increasing market share, as the company capitalizes on cross-marketing opportunities from customers who have been combining the types of electrical and mechanical products the company offers.
Growth should also get a boost from the introduction of new products and sales of custom products. In addition, management plans to continue pursuing strategic acquisitions in an effort to further bolster top-line growth.
HOT TREND. Toward that end, Regal-Beloit recently announced two major acquisitions in its electrical motors business, which should more than double its total sales. In August, 2004, the company completed the purchase of GE's commercial air-conditioning motor business for $72.5 million. The business operated a manufacturing facility in Juarez, Mexico, had technology resources in Hyderabad, India, and had a joint venture relationship in China.
The Beloit (Wis.) concern took an even bigger step in December, 2004, closing a deal to buy GE's heating, ventilation, air conditioning, and refrigeration motors, and capacitors operations for approximately $400 million. This transaction will, in our view, significantly improve its position in the HVAC market, add key new motor technologies, increase capacity in strategic locations, and provide a somewhat less cyclical business to the mix. Management estimates that about 70% of the finished HVAC units are sold into the replacement market in the U.S., and this market is driven more by weather conditions than economic activity.
Regal-Beloit's management believes the GE motors-and-capacitors deal, completed on Dec. 31, 2004, will add about $500 million to 2005 sales and 52 cents to 54 cents to EPS, excluding one-time charges. We do not include any benefits from the planned deal in our 2005 EPS estimate of $1.75. In our opinion, Regal-Beloit will likely experience double-digit revenue growth in 2004 and 2005, as end markets recover and price increases are implemented.
POWER SURGE. Despite the recent upward pressure on raw material costs, we believe the company will be able to expand margins going forward, as cost-control initiatives are finally leveraged into earnings with rising volumes. In its effort to continuously lower the cost structure, Regal-Beloit will continue to focus on attaining operating synergies from acquisitions, improving efficiencies, consolidating plants, and taking advantage of sourcing and logistics opportunities.
Following several years of restructuring efforts, the company will to be able to expand its margins in 2004 and 2005, as it gains leverage from volume increases, in our opinion. However, we believe margin growth will be tempered in 2004 by rising raw material costs -- particularly for steel -- that will not be fully recovered in price increases.
After a decline in interest expense, we forecast 2004 earnings to increase 20%, to $30.2 million ($1.22 per share). Our 2005 estimate calls for a 43% rise in earnings, to $43.1 million ($1.75 per share).
The Standard & Poor's Core Earnings-per-share projection is $1.14 for 2004 and $1.68 for 2005. Our S&P Core EPS estimate for 2004 includes anticipated stock-based compensation expense of about $500,000 (2 cents per share). In addition, we project pension-related costs of about $1.5 million (6 cents per share) in 2004.
NICE DISCOUNT. Our 12-month target price of $35 values shares of Regal-Beloit at 20 times our 2005 EPS estimate, in line with its peer group's average multiple. The shares currently trade at 18 times forward 12-month earnings -- a meaningful discount to their peer group's average p-e multiple of 21. Regal-Beloit also appears undervalued based on our
discounted cash-flow model.
Risks to our recommendation and target price, in our view, include any difficulties associated with the timely closing and integrating of acquisitions, a slowdown in worldwide economic growth, problems implementing price increases, and increasing raw material prices. Analyst Hingher follows diversified materials stocks for Standard & Poors Equity Research