Seeking Small-Cap Moats: John Bean Technologies
John Bean’s high levels of recurring revenue and high customer switching costs make it a promising small-cap name for further research, says Morningstar’s Todd Wenning.
This article is part of Todd's monthly series "Seeking Small Caps With Moats." The introductory article can be found here. New articles in the series are published on the fourth Wednesday of every month.
Small-cap companies, as a group, tend to have less consistent results than their larger peers, so one of the things I love to see when researching a small cap is a significant amount of recurring revenue that yields more predictable and profitable results. Indeed, one of investing legend Peter Lynch’s signs of a perfect stock is that people have to keep buying the product. As he notes in his book One Up on Wall Street, “Why take chances on fickle purchases when there’s so much steady business around?”
Further, firms that consistently generate high levels of recurring revenue can often possess a durable competitive advantage derived from switching costs. In other words, if customers are willing to provide steady business to one particular supplier, there are likely tangible or intangible costs associated with switching to another supplier. So as I was searching the small-cap universe for companies with potential economic moats, I was keen on finding firms that generated high levels of recurring revenue. I believe I've come across one in John Bean Technologies (JBT), an $846 million company that provides technology solutions to the food processing and air transportation industries.
Before we dig further into JBT's business, I should note that it possesses additional key ingredients that I look for in a small-cap company. Taking another page out of Lynch's playbook, it has a funny-sounding name (few people would brag to their friends about owning a company called "John Bean"), it operates in unexciting industries (juice extractors and airport gate equipment), and it has fewer than five sell-side analysts covering it. At first glance, then, JBT is a promising small-cap name for further research.
Meet John Bean
The company gets its name from its founding father, John Bean, a retiree from California who came up with a better way to spray insecticide on the region's fruit orchards and created the Bean Spray Pump Company in 1883. After a number of corporate actions over its 130-year history, the current JBT was spun off from energy company FMC Technologies in 2008.
JBT's history is important because over time the company has developed extremely strong customer relationships and has installed more than 40,000 pieces of food processing equipment, 9,300 airline cargo loaders, 7,700 passenger boarding bridges, and 4,600 aircraft deicers, among other installations. From this broad base of installed equipment, JBT can generate a significant amount of higher-margin recurring revenue. In 2012, 45% of JBT's revenue came from three recurring revenue streams: aftermarket proprietary parts, long-term equipment leases, and airport services.
Source: Company filings, Morningstar estimates. Based on trailing 12-month figures.
Even though JBT already has a large installed base of equipment, the business' growth runway remains healthy. Growth drivers in the FoodTech business include equipment replacement cycles, dietary trends in developed markets toward convenience (such as frozen ready-made meals), and stronger protein demand in emerging markets. The AeroTech business is benefiting from terminal expansion projects in developed markets and new airports in emerging markets, demand for mobile ground power units that allow planes on the tarmac to function without burning fuel, and growing demand for deicers.
Digging Into the Numbers
JBT has an interesting story, but does it have an economic moat? Let's start by taking a look at JBT's margins and returns on invested capital.
At first glance, you'll see that JBT's margins aren't particularly robust, which could be a problem if the company has low asset turnover, but that's not the case here, and JBT's returns on assets and invested capital are pretty good. Even in recent years, returns on invested capital appear to be consistently above the company's cost of capital--a positive indicator that the company possesses an economic moat.
Before we can feel confident about JBT possessing a moat, however, we need to answer the following question: From which of the five economic moat sources might the company derive a durable advantage?
JBT may derive some benefit from intangible assets through its patented technology--it owns 434 U.S. and foreign patents--and manufacturing know-how, but switching costs are likely the more important economic moat source for JBT. In both business lines, most of JBT's products are "mission-critical" in nature, and its customers aren't inclined to switch providers based on price alone. If you're a citrus grower processing a million gallons of orange juice at harvest time or if you're an express delivery company using JBT's loaders to keep your airport logistics running efficiently, quality and reliability are the main considerations. Unless JBT's installed equipment and services really fail to deliver, you're unlikely to switch to a competitor to save a few pennies, especially if you also have to retrain your staff on new equipment.
Morningstar doesn’t have full analyst coverage on JBT, and the company hasn’t been vetted by our moat committee to produce an official Morningstar Economic Moat Rating, but after reviewing the evidence, it’s my opinion that JBT has a narrow economic moat that can help it generate returns above its cost of capital over the next 10 years.
Now, whether JBT will achieve those results will depend largely on the capital allocation decisions that will be made by the new management team. (Everything sounded great until this point, right?) In August, JBT announced a management transition in both the CEO and CFO roles and announced Tom Giacomini, previously the CEO of Dover Corporation's Engineered Systems division, a $3.6 billion business, as the company's new chairman and CEO. Giacomini started his role in September and a new CFO has yet to be determined, but the current CFO is holding off on his retirement until a replacement is named.
Such a significant executive transition is indeed a risk, but I don't believe this is a huge red flag given that both of the outgoing executives had been with JBT and its former parent companies for more than 30 years, they successfully transitioned the JBT spin-off over the last five years, and they are ensuring a smooth hand-off to the new team.
The new executive team inherits a very solid balance sheet (debt/EBITDA of 1.2 times) to work with and will have a mandate for growth. This presents an opportunity to extend JBT's growth runway into new technologies and geographic markets, but it also presents a risk of "empire building" if new management seeks to make its mark in a big way early on. Ideally, management will make smaller bolt-on acquisitions that will complement its existing core competencies and, more important, avoid overpaying for them. I'd become skeptical of management's stewardship of shareholder capital if it were to seek a "transformative" acquisition or overpay for a series of smaller acquisitions. That said, I do take some comfort in the fact that new CEO Tom Giacomini comes from a solid capital allocation tradition at Dover, a successful company with a good track record of making bolt-on acquisitions.
In terms of whether or not JBT is a good buy today, the stock has made a very strong run year to date, up 64% through Nov. 25.
With a free cash flow yield near 4.5% today, JBT isn't exactly a value play, but it's also not a complete "hope" stock.
Obviously I wish I could have highlighted the stock when it was trading with a 10% free cash flow yield earlier this year, and yet, the current market price remains slightly below my fair value estimate. Assuming a 9.5% weighted average cost of capital, midsingle-digit revenue growth through 2018, and segment margins approaching management's targets of 11%-12% for FoodTech and 10% for AeroTech, I'm comfortable assigning a base-case fair value range of $30-$33. Unfortunately the stock has traded higher in the days prior to scheduled publication, and there isn't a sufficient margin of safety with JBT trading near $29 as of Tuesday. I'd be much more comfortable starting a position below $27 and will do so in my personal portfolio if the opportunity presents itself.
Do you have any questions about John Bean Technologies? Please add your questions, comments, and feedback in the comments section below.
Todd Wenning does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.