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From the Survey: Sauer-Danfoss
Sauer-Danfoss (SHS) designs, manufactures, and sells a variety of engineered hydraulic and electronic components for off-highway vehicles. The company provides custom solutions to Original Equipment Manufacturers (OEM), primarily in the agriculture, construction, and road building markets. Sauer-Danfoss operates over 20 engineering and manufacturing facilities across Europe, the Americas, and the Asia-Pacific regions. With 2009 revenues of nearly $1.2 billion and a market capitalization of approximately $1.5 billion, Sauer-Danfoss is a mid-level player in the Machinery Industry, similar to Actuant Corporation (ATU), and Regal-Beloit Corporation (RBC).
Historically, machinery stocks, such as Sauer-Danfoss, Caterpillar (CAT – Free Caterpillar Stock Report), or Deere & Company (DE), are cyclical, which means that movements in the stock’s price exhibit a positive correlation with the business cycle. Hence, shares of machinery firms typically outperform the broader market averages in periods of economic expansion and underperform the market during economic contractions. Although cyclical stocks tend to fluctuate in relation to the business cycle, the movement is not in lockstep with the economy. Price declines normally lag a downturn in the aggregate economy by a few months, while price increases usually presage an economic expansion.
Keeping in mind the cyclical nature of Sauer-Danfoss’ stock, the price started to falter in late 2008 about nine months after the recession began. The price hit a low in the first half of 2009-- at $2.40 per share, a 94% collapse from its 2008 high of $37.90. Poor share-earnings appear to be responsible for the precipitous price decline. The company lost $0.60 a share in 2008, followed by a loss of $7.15 in 2009. The large dose of red ink included an operating loss, combined with a goodwill impairment charge and restructuring expenses.
During the downturn, the company responded by suspending its dividend payment, selling an unprofitable business, and launching restructuring initiatives. When the recovery began to gain steam in the latter half of 2009, the stock’s price found support in the mid-single-digit range. Earnings per share moved from the red into the black in the first half of 2010, while the share price fluctuated around $12. In July, the stock took off. The price rose about 150%, to just over $30 a share. So, is there any room left to run? There are a few reasons to be optimistic.
Improving Operating Environment
Sauer-Danfoss’ sales and earnings per share have rebounded nicely so far this year. During the first three quarters of 2010, the top line gained 38%, to $1.2 billion from $880 million in the year-earlier period. Year to date, the company has reported share earnings of $1.77, setting a record of $0.71 for quarterly earnings per share in the second quarter. Undoubtedly greater volume and the reversal of deferred tax asset valuation allowances contributed to bumper bottom-line results, but reduced costs and wider margins resulting from restructuring efforts played a role as well. For instance, the 2010 operating margin will probably approach 16%, which is well above the previous business cycle’s average operating margin of 12%. If the company maintains its current margins, the current uptick in the business cycle should be quite profitable.
New Business Strategy
On July 1, 2010, the company launched three new businesses that encompass all of the cartridge and hydraulic integrated circuit (HIC) valves, gear pumps and motors, and inverter products previously manufactured and marketed by the central Sauer-Danfoss organization. Under the new organization, Comatrol will design, manufacture, and sell cartridge valves and HICs. Turolla OpenCircuitGear will design, manufacture, and sell open circuit gear pumps and motors, and Schwarzmüller-Inverter will produce and market electric inverter products. All three brands are fully ownded by Sauer-Danfoss Inc. The company will continue to handle hydrostatic propel, orbital motors, and electronic components under the Sauer-Danfoss title. Management believes that these smaller divisions will be more agile and better equipped to suit customers’ needs. In addition, Sauer-Danfoss has implemented a new sales strategy, focusing on a single point of contact for both service and warranty, enhanced technical support, and aligned sales processes. Thus far, the new business strategy appears to have been quite successful.
Considerable Cash Flow
During the first nine months of 2010, cash flow from operations more than doubled to $188 million, from $75.6 million in the comparable year-earlier period. The company has utilized some of its cash flow to lower debt. Sauer-Danfoss began 2010 with approximately $480 million in total debt, which has been reduced to $341 million on September 30, 2009. Decreasing leverage and an improving cash position augur well for the company’s future. Most likely, debt levels will continue to shrink over the coming 3 to 5 years, allowing the company to use funds to expand its business or perhaps reinstate the dividend payment.
After an impressive rally in its stock price during the second half of 2010, Sauer-Danfoss appears well positioned to succeed over the pull to 2013-2015. The new business model will probably result in top- and bottom-line improvements for years to come. Furthermore, the company may reinstate the dividend payment, which would boost total return potential. However, the rally discounts much of this stocks’ long-term price appreciation potential.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.