Saturday, May 13, 2017

A current AIM Fund holding: Franklin Electric (FELE) by Stephen Arcuri. “FELE has Primed the Pump - Ready for Infrastructure Spending”


Franklin Electric (FELE, $37.40): “Franklin Electric has Primed the Pump”
By: Stephen Arcuri, AIM Student at Marquette University


Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

 Summary

Franklin Electric (NASDAQ:FELE) is an international developer, manufacturer, and distributor of pumps that move groundwater, wastewater, and fuel. FELE operates in three segments, Water Systems (80% of revenue) and Fueling Systems (20% of revenue), and an “other” segment which is used to house corporate and administrative costs.

• FELE recently announced a series of acquisitions to establish the new Headwater Companies entity, a new distribution segment that will report separately. The purchase of Western Hydro Holding Corporation, and California and Drillers Service, Inc. and 2M Company Inc. are all set to close by the end of 2Q 2017.

• FELE is set to recognize gains from a more favorable product mix as Fueling Systems (9% organic growth) takes up a larger share of revenue compared to Water Systems (-1% organic growth).

Key points: Investors were disappointed in late April by Franklin Electric’s earnings miss, as both Water Systems and Fueling Systems saw operating margins fell to 13.0% and 20.7% respectively. This along with a weaker than expected first quarter sales and higher than expected acquisition costs seems to have caused many investors to think Franklin Electric has run dry.

Franklin Electric’s shocking strategy will soon jump start its shares again. Domestically, Franklin Electric looks to cut costs by vertically integrating and starting a distribution segment. This move will improve Franklin Electric’s footprint and service capabilities, with 60 new locations and 500 new employees. The new segment is expected to bring additional annual sales of $275 million and have an operating margin from 4-6%, bringing management’s 2017 estimate to between $1.77 and $1.87.

Only 30% of emerging markets currently utilize pressure pumping technology, an industry standard in the developed world. Franklin Electric’s diverse revenue stream, only 46% of revenues come from the United States, is positioned to capitalize on international organic growth. Fuel revenues saw 11% organic international growth YOY in Q1. Improving tailwinds, namely stable oil prices, suggest that infrastructure in emerging markets related to gas and oil will continue to increase. A weakening of the dollar relative to the last two years will also present foreign investors with a better buying opportunity for at least the near future.

Market penetration is key for Franklin Electric, as 80% of revenue comes from replacement parts rather than first time sales. Organic growth sales have, and still largely do, represented initial sales rather than revenue from replacement parts. As these markets mature, FELE will be able to further capitalize on their initial success. Until then, the diversification of their business with the new distribution segment will help to generate more consistent revenues.

What has the stock done lately?
Franklin Electric has experienced a 16.42% drop in price since their earnings call on April 28th, 2017. This presents buyers with an excellent opportunity to take a long-term position while Franklin continues to recognize one time transaction costs that drag earnings per share.

Past Year Performance: FELE is down only 3.86% year to date, despite experiencing a drop of 16.42% since April 28th. Year over year, however, Franklin Electric is up 14.79% as they have continued to improve their margins and strategically position themselves both domestically and internationally.

Source: FactSet

My Takeaway

Despite the Q1 earnings miss, Franklin Electric has a strong long term outlook as they expand internationally and vertically integrate domestically. Short term profitability will likely be hurt as the synergies and integration with the distribution segment take time to materialize, but the decrease in stock price represents a buying opportunity to long term investors. 


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