Graham Corporation: A Mixed Bag Of Financial Metrics With Growth Potential (NYSE:GHM)

Thesis

In this analysis, I assess the financial health, growth prospects, and challenges of Graham Corporation (NYSE:GHM), a player in the defense, space, and emerging energy sectors. Weighing these factors, I propose that GHM is poised for growth but investors must be cautious of these looming risks.

Company Overview

In examining the operations of Graham Corporation, it’s apparent that the firm, along with its subsidiaries, maintains a pivotal role in the production of diverse equipment, including fluid, power, heat transfer, and vacuum components. Their offerings are ubiquitous across various sectors including the chemical, petrochemical, defense, space, petroleum refining, cryogenic, and energy industries.

A closer look at their portfolio reveals a comprehensive list of products. Key offerings include power plant systems—ejectors, surface condensers—and torpedo ejection, propulsion, and power systems—turbines, alternators, regulators, pumps, and blowers, all of which form the backbone of many critical infrastructures.

In the defense sector, Graham’s thermal management systems, constituted by pumps, blowers, and drive electronics, are the foundation of complex military apparatus. For the space industry, the company produces rocket propulsion systems comprising turbopumps and fuel pumps, cooling systems, and life support systems, reflecting the firm’s strategic engagement in this high-growth sector.

They’ve extended their offering to the energy sector, supplying heat transfer and vacuum systems, power generation systems, and thermal management systems, showcasing their expansive technical capabilities. Further drilling down into the chemical and petrochemical processing industry, their suite of heat transfer and vacuum systems play an integral part in these complex industrial processes.

Notably, Graham Corporation extends beyond product offerings and ensures customer satisfaction through providing services and selling spare parts for their equipment, effectively building customer loyalty and ensuring recurring revenue.

Geographically, Graham Corporation maintains a global reach that spans from its home in Batavia, New York, to Middle East, Canada, Asia and South American markets and beyond.

Expectations

Currently, Graham Corporation is covered by two Wall Street analysts who both rate the stock a “Strong Buy” with a healthy upside projection of 60%+ at the time of my coverage.

Performance

Relative to its peers, YTD, Graham Corporation has notched an impressive 35% return, which practically mirrors the gains of FSTR, NNBR, and PKOH within the past two months.

Valuation

Let’s start with the good news. GHM’s EV/Sales metrics, both trailing twelve months (TTM) and forward (FWD), are well below the sector median, grading B+ and A-, respectively (see below). These ratings suggest GHM generates significant revenue relative to its enterprise value, which is a positive sign.

If we look at the company’s Price/Sales and Price/Book metrics, they are also below the sector median. This indicates that the market might undervalue GHM’s sales and book value, making it potentially an attractive pick for value investors.

However, this rosy picture becomes gloomy when we turn our attention to GHM’s EV/EBITDA and EV/EBIT multiples. These valuation metrics are sky-high, especially the TTM figures, which means the company’s earnings before interest and taxes are significantly low relative to its enterprise value. It’s an immediate red flag, indicating either the company is overvalued or its profitability is currently suffering.

The GAAP P/E ratios are simply stratospheric. A TTM P/E of 441 and forward P/E of 101.77 is alarming. The usual interpretation of such high P/E ratios would be that investors are expecting high earnings growth in the future. However, in this case, I fear it is more reflective of poor recent earnings, especially since these ratios are massively higher than the sector average.

Furthermore, the company’s EV/EBIT multiples, both TTM and forward, are significantly higher than the sector median. These ratios tell us that GHM’s operating profitability is quite low compared to its total enterprise value, and the company may be overvalued.

Finally, on the capital structure side, the firm has a manageable debt level, and its market cap stands at $141.25M. It also holds a reasonable amount of cash. However, the company’s enterprise value, which factors in this cash and debt, stands at $143.37M. This indicates that the market values GHM’s business operations (or, more specifically, its future earning potential) at just above its equity plus net debt, which is a rather lukewarm assessment.

Q4 2023 Bullish Earnings Takeaways

Let’s start with revenue growth and diversification: Graham Corporation has impressively pulled off a 28% YoY increase in revenue, bringing their annual earnings to an all-time high of $157 million. The successful revenue diversification strategy the company has deployed is particularly noteworthy. They’ve expanded beyond their core business into new market segments, including Defense, Space, and emerging energy sectors. This diversification not only guards against revenue volatility in any one area but also positions Graham Corp. to capitalize on burgeoning trends in Defense and Space, which have seen modest growth.

Healthy Order Book

Graham Corporation’s order book shows a compelling story of future growth. Graham’s products continue to experience strong demand with 50.8 million orders in just the 4Q and record total orders totaling $202.7 million for the year. Book-to-bill ratios (1.2x for Q4 and 1.3x for YTD) further demonstrate this, with orders outpacing revenues, giving promise for future sales growth. It implies a robust pipeline of revenue, setting the stage for continued growth and financial health in the coming periods.

Margins Expansion

The company has managed to more than double their gross margin to 16.2% from a meager 7.4% in the previous year. This remarkable turnaround points to improved operational efficiency and the potential benefits of their diversified revenue sources. As Graham Corporation moves to complete its remaining first article orders and as better-priced contracts contribute more to revenue, we can anticipate further margin expansion. This trajectory, if maintained, bodes well for enhanced profitability.

Balance Sheet Strength

Graham Corporation’s financial position appears robust and stable with cash generated from operations totaled $13.9 million, and debt reduced by an impressive $6.6 million. Cash and cash equivalents had also grown year over year to reach $18.3 million. This healthy cash position, coupled with reduced indebtedness, provides Graham Corp with modest financial flexibility.

Promising Guidance

Finally, Graham Corporation’s future outlook is quite promising. They’re expecting an 8% YoY top-line growth, consistent with their long-term growth strategy. CFO Chris Thome noted on the conference call that:

These expectations as well as the results for fiscal 2023 allow us to raise our fiscal 2027 revenue goal, which is now expected to exceed $200 million, the target just said a year-ago.

The forecasted adjusted EBITDA margin of around 6% to 7% underscores the anticipated efficiency gains and profitability improvements. If realized, these targets could solidify Graham Corporation’s position in its markets, enhance shareholder value, and further fuel its growth engine.

Risks & Headwinds

Now, let’s delve into some financial concerns surrounding Graham Corporation that warrant careful attention. A significant customer in the space sector filed for bankruptcy this quarter, inflicting a net impact of $2.5 million on Graham Corp.’s financials. While the firm has managed to absorb this blow within the year’s performance, it’s a stark reminder of the potential credit risks inherent in the space industry. This incident might be a single event, but it underlines the importance of diversified clientele to mitigate sector-specific risks.

Refining Sales Downturn

Refining sales took a downturn by $4.2 million, mirroring the reduction in capital projects in the refining market. While aftermarket demand remains robust, which offers some respite, the persistent weakness in refining sales could become a red flag if not addressed promptly.

Rising SG&A Expenses

SG&A expenses climbed by $1.4 million over the previous year, reaching $7.5 million. This surge in overheads could weigh on profitability if not effectively managed. It signals a need for tighter cost control measures to ensure that such expense inflation doesn’t erode the earnings growth Graham Corporation has been achieving.

Net Loss in 4Q

Graham Corporation posted a net loss of $0.05 per diluted share, translating to a total loss of $481,000 for the quarter. This underlines the adverse impact of the bankruptcy incident with the space customer and perhaps hints at operational hurdles the company is grappling with.

Dependence on Defense Contracts

Finally, while the aforementioned defense sector has been a growth catalyst for Graham Corporation, this reliance does carry inherent risks. Specifically, changes in defense budgets and geopolitical uncertainties could severely affect the business.

Final Takeaway

Graham Corporation, despite financial challenges such as an increase in SG&A expenses and customer bankruptcy as well as refining sales decrease, remains on track for future growth. GHM achieved significant YoY revenue growth, healthy order book and margin expansion while maintaining a stable balance sheet – all indicators that investors may find value in holding onto this stock given GHM’s ongoing efforts to diversify revenue sources, strengthen market positions and maintain robust future prospects.