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.
