Plenty of Upside for Actuant

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, Co-Editor of Morningstar's OptionInvestor. Today it's my great pleasure to welcome Daniel Holland, who is an Equity Analyst in-charge of Diversified Industrials here at Morningstar.

Daniel, thanks for coming.

Daniel Holland: Thanks for having me, Erik.

Kobayashi-Solomon: So, just recently I wrote an article describing a bullish option strategy on a company that you cover Actuant. I think first of most of the people who are watching this or who read the article had never heard of Actuant before. I know they've got a bunch of little kind of product lines; can you talk a little bit about Actuant and how it got the way it is?

Holland: Well, Actuant is an interesting company, in that they, as you mentioned, have consolidated a lot of smaller brands and one of the gems of the whole portfolio is its Enerpac business, hydraulic bolt tighteners, things that you know infrastructure projects need in order to think of putting bridges together, building roller coasters, things like that, where you need really high powered torque wrenches to get in there and tighten things up.

Kobayashi-Solomon: The reason that it's so attractive is that it doesn't sound like the kind of business that a huge amount of volume goes through. So, these larger companies don't want to involve themselves in it. So, basically Actuant is a 800 pound gorilla on the block, is that right?

Holland: That's right, and to that extent, even if they could, the company is so entrenched and has such a dominant market share in certain areas that it's just really not attractive for folks to go in and try and compete against them.

Kobayashi-Solomon: So, basically what they've done is picked some nice niches and they really own those niches, those niches are too small for a really big player like a GE or somebody and too big for just a mom-and-pop to get into it.

Holland: Right, that's fair to say.

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Kobayashi-Solomon: I see. So, one of the business, one of the business lines that you've written a lot about is this oil services, and I know that they have acquired a lot of businesses, a lot of these niche businesses are things that they find and buy, and you were a little worried about the price that they paid for this oil services, what's your thinking on that right now?

Holland: Well, as you think about it just coming into right before the recession, Actuant had kind of gone on a little bit of a spending tear, really beefing up this energy business, transforming it from something that was kind of a small part of the portfolio to actually being a pretty major part of the business.

Kobayashi-Solomon: So, just to refresh everybody's memory, this is when oil was going from $60 to $80, to $100 to $140 or whatever.

Holland: That's right.

Kobayashi-Solomon: So it looked like a pretty good idea at the time?

Holland: That's right, and it still probably is a very good idea given that oil is a limited natural resource and it's going to be more difficult to get oil out of the ground, therefore you're going to need more highly-sophisticated engineering to get that – get oil out of the ground and the equipment that's doing that's going to need more maintenance, which happens to be Actuant's specialty is equipment that helps maintain and keeps assets moving at its optimal level.

Kobayashi-Solomon: Okay. So, they're growing this business. It's looking pretty good and it seems like something that will have good fundamental demand. What about the situation at Gulf right now, how affected are they by, let's say, the oil drilling ban out there?

Holland: At first, you have to say it's a short-term negative event, when you have a moratorium basically placed on a certain region of the available assets out there. But as you think longer-term about it, one of the ramifications might be that asset owners are going to be required to do more maintenance on equipment, make sure that everything is up to spec, so that they can go out and drill for oil.

Kobayashi-Solomon: So, it could actually be a bullish source of uncertainty for these guys?

Holland: Over the longer-term horizon, I absolutely believe that.

Kobayashi-Solomon: I see. Let's talk a little bit about your valuation scenarios. What do you think is, let's say, a best case for these guys, what their worst case?

Holland: As you start to think about some of the different growth scenarios. One of the interesting things about Actuant's portfolio is very late cycle, meaning that, a number of the different businesses aren't necessarily going to start rebounding until there is more heavy capital spending, and that typically comes later in the cycle.

Kobayashi-Solomon: So, this is obviously, it's not a consumer good, this is industrial good.

Holland: That's exactly right, and so, as I think about that and say, well, in a very good scenario, you can actually start seeing more revenue coming back in 2011 and even in 2012 type of range where you could have pretty strong double-digit growth. And so, in an optimistic scenario, I could say that, between those two years, maybe 15% is not too strong of reach, given how far back it fell in 2009.

Kobayashi-Solomon: So, really a bounce back, kind of a spring bouncing back. How about on the worst case side?

Holland: Worst case scenario, you start to think, well, maybe all of the economists out there are right that double dip and stagnant economy across the globe will really impact Actuant, and so if I think about that I'd say, maybe they're going to be flattish, to maybe some single-digit downward over the next couple of years.

Kobayashi-Solomon: That means revenue growth?

Holland: That's revenue growth, that's right. And as you think about that, they impact you, the valuation, we'll put it somewhere in the teens from my perspective and if you think about that and where the stock is currently trading at is, it's not a lot - it not very far away from where the stock is currently trading, so there is in my opinion, a fair amount of upside ability in the stock.

Kobayashi-Solomon: And a fair amount of limited downside let's say.

Holland: That's right.

Kobayashi-Solomon: It sounds like a good bet to me.

Holland: And from my perspective.

Kobayashi-Solomon: Daniel, thanks for coming in.

Holland: Thanks for having me, Erik.

Kobayashi-Solomon: And thank you for joining us. Please stop by the OptionInvestor website, where you will find more option ideas based on Morningstar's Fundamental Research.