Day: April 9, 2024

Introduction and thesis

Atmus Filtration Applied sciences (NYSE:ATMU) is a number one participant within the filtration trade, specializing within the design, manufacturing, and distribution of progressive filtration options. The corporate has established itself as a key participant in offering sustainable and high-performance filtration methods throughout numerous sectors.

Atmus is a spin-off from Cummins (CMI), which continues to carry a majority place within the firm however is in search of to get rid of its total holding.

Atmus’ spin-off is a mirrored image of its present market place. The enterprise is a frontrunner in an trade that shall be considerably disrupted by the electrification development, requiring innovation to create a brand new and improved worth proposition.

Atmus at the moment has substantial execution danger to reinvigorate its long-term development trajectory, significantly given the understanding of the transition away from its core expertise. We’ve but to see ample progress to guarantee income alternative and wholesome development long run.

The enterprise is positioned fairly effectively to reply with robust money flows and restricted debt, nevertheless, any upside past this isn’t priced in. We suspect this may take no less than 5 years, with restricted certainty. With Atmus buying and selling at a small low cost to its friends, we imagine the inventory is probably going inside vary of its truthful worth.

Share value

Atmus’ share value efficiency for the reason that firm was listed has been robust, with a current run-up taking the inventory forward of the broader market.

Monetary evaluation

Offered above are Atmus’ monetary outcomes.

Enterprise Mannequin

Established as a number one supplier within the business filtration market, Atmus makes a speciality of equipping (on/off-) freeway automobiles with a complete vary of options. Its product portfolio extends past conventional gas and air filters, encompassing crankcase air flow methods, coolants, and different specialty chemical compounds.

Designed to attenuate emissions and guarantee optimum car safety, Atmus merchandise allow environment friendly utilization, prolonged service intervals, and decrease prices for his or her clients.

The corporate has progressively expanded its goal market, as Administration seeks to diversify the corporate and enhance its development potential. This has grown in significance as a result of electrification development, as this poses a elementary danger to Atmus’ trade. In concept, a whole transition to wash vitality would eradicate the necessity for minimizing emissions, eliminating Atmus’ enterprise. In actuality, this won’t be the case, nevertheless, the basic danger stays and can compound over the approaching a long time.

Administration is actively in search of to deal with this by the next 4 factors, with the broader goal being to maximise its present efficiency at the moment to fund the enlargement and innovation of its operations.

We do see cheap scope to reach this regard, though how “success” materializes is troublesome to evaluate. As a number one enterprise in its section, the corporate has a powerful model and deep experience, positioning it effectively to supply factors 1-3.

Atmus has relationships with a lot of main OEMs, growing its scope for penetration by leveraging its belief and capabilities to ship at scale. It’s far simpler for Atmus to cross-sell to OEMs than small opponents missing relationships and a world footprint. This positions Atmus to enter associated industries or develop manufacturing.

Additional, the corporate has excessive publicity to the aftermarket section and the FCF era essential to reinvest into its provide chain to drive effectivity.

The priority now we have is that we don’t imagine factors 1-Three shall be ample to maneuver the needle long-term, the corporate wants elementary innovation past associated merchandise. This must be in a futureproof vertical however leverages its current capabilities. Administration has recognized industrials as probably the most real looking avenue, and we concur. This can probably require M&A and reinvestment of FCFs, which Atmus is able to do.

Financials

Atmus’ current efficiency has materially slowed, with top-line development of +9.4%, +5.2%, and (1.2)% in its final 4 quarters. Regardless of this, as now we have touched on beforehand, its margins have been unwaveringly constant.

We attribute the decline in development primarily to the macroeconomic points mentioned, with softening capital spending as demand is predicted to step down. Shoppers and companies are more and more involved in regards to the near-term outlook, turning defensive. We imagine its margins mirror the basic power of the corporate, implying competitors stays at a stalemate.

Additional, Administration has highlighted that the corporate has benefited from each softening inflationary pressures on its supply-chain and continued elevated pricing, with quantity being the offsetting issue. These are small positives that recommend Atmus can have a smooth touchdown in 2024.

Present financial circumstances characterize near-term headwinds for Atmus. With elevated charges and inflation, customers are going through a cost-of-living disaster and companies try to guard margins whereas sustaining a steady capital place.

Earlier than discussing how this may influence the corporate going ahead, it’s value pertaining to how this has impacted development lately. Inflation has allowed Atmus to raise costs, though noting this has been broadly offset by rising prices, contributing to net-neutral margins. Additional, numerous car industries skilled supply-chain points as a result of a scarcity of semiconductors and a low ramp-up in manufacturing services post-pandemic, contributing to cost inflation. This has contributed to a greater-than-expected development price.

Wanting forward, we anticipate demand to melt within the coming quarters, as financial circumstances worsen, impacting capital demand. The US recession chance indicator has exceeded 50%, whereas unemployment throughout the West slowly begins to tick up. With retail gross sales broadly flat M-o-M, we see the economic system as weak.

This mentioned, the expectation is for charges to say no in 2024, no less than within the US, which might act as an offsetting issue and contribute to a smooth touchdown. With pricing off the desk and demand more likely to be decrease, we predict development to be (2)%-2% in FY24.

Atmus’ flat margins are a mirrored image of its main trade place, permitting the corporate to keep up its unit economics regardless of altering market circumstances. Conversely, this implies restricted scope for enchancment with out ground-breaking innovation.

We do imagine Atmus might drive enchancment by the supply of its strategic targets, specifically diversification by increasing into industrials contributing to larger scale and elevated aftermarket actions contributing to accretive gross sales.

This mentioned, we’re hesitant to recommend this may have an effect within the coming Three years, because the monetary contribution will not be ample to maneuver the needle. This mentioned, each elements are basically essential to the long-term success of the corporate, and so margin enchancment is a secondary profit. It’s value highlighting that an EBITDA-M of ~16% that broadly interprets to FCF returns is spectacular.

Offered above is Wall Avenue’s consensus view on the approaching years.

Analysts are forecasting poor development within the coming years, with a CAGR of two% into FY25F. Together with this, margins are anticipated to stay broadly flat.

We concur with these forecasts. Regardless of reinvestment and a transparent strategic route, it’s unlikely that Administration will remodel itself by FY25F. Even because it does, the corporate will probably see an offsetting downward stress as car segments more and more transition to wash vitality.

Steadiness sheet & Money Flows

Atmus has a bulletproof stability sheet, owing to its constant FCF era, permitting for restricted debt utilization. The corporate at the moment has a ND/EBITDA ratio of 1.7x and curiosity protection of 11x.

We wish to see Administration make the most of this FCF to innovate and develop its enterprise mannequin, be it by M&A or natural means, permitting for an enchancment in its development potential.

Trade evaluation

Offered above is a comparability of Atmus’ development and profitability to the common of its trade, as outlined by Searching for Alpha (27 firms).

Atmus’ monetary efficiency is respectable, however its weaknesses commercially are clear to see. The corporate boasts superior margins, owing to its market-leading place and maturity of its merchandise.

Towards this, nevertheless, is development, which is comfortably under its friends. As its industries transition away from filtration wants, the corporate has seen softening demand. Additional, a level of that is its inherent place out there. The corporate is a frontrunner however targets extremely mature industries, limiting its scope for capturing engaging development.

Valuation

Atmus is at the moment buying and selling at 9x LTM EBITDA and 8x NTM EBITDA.

This valuation represents a reduction to its friends on an LTM EBITDA foundation (~1%) and NTM MC/FCF foundation (~58%). That is cheap in our view, as regardless of its robust FCFs and margins, we imagine the threats to its enterprise mannequin are ample to offset the premium anticipated from this. Development being decrease than common is just not essentially the priority as a result of margins, however when factoring in the advantages of inflation, the delta is definitely far bigger.

Till Atmus can illustrate a long-term development trajectory above the inflation goal, we imagine a reduction to its friends is warranted. This means the inventory is inside vary of its truthful worth.

Key dangers with our thesis

The dangers to our present thesis are:

• Profitable transition into industrials.
• Innovation in filtration expertise.
• Regulatory challenges impacting operations as industries transition to wash vitality.
• Elevated value competitors affecting market share.

Last ideas

Atmus is a high quality enterprise, owing to its market-leading place, deep experience, and trade relationships. The problem the corporate faces is a elementary change in trade applied sciences, which over the approaching a long time might contribute to a decline in Atmus’ significance.

Administration is actively in search of to pivot the corporate however would require time and funding. At this stage, significantly following a substantial share value run, we don’t see upside.