Crane CR owns a portfolio of moaty businesses that tend to be leaders in their niche markets, typically holding a number-one or -two share. It makes a wide range of products, including valves, banknote validators, and aerospace components, but a common thread across its portfolio is that Crane manufactures highly engineered products that often perform mission-critical functions. Crane has consistently generated solid returns on invested capital, averaging around 14% over the past 10 years, and we think the company is well positioned to continue outearning its cost of capital thanks to its narrow economic moat. Although the coronavirus outbreak will make 2020 a tough year for Crane, the company remains on solid financial footing.
We think Crane has built a moat around its business based primarily on intangible assets, including its engineering prowess and reputation for quality and reliability. Furthermore, we believe that Crane benefits from customer switching costs associated with its large installed base of equipment. For instance, its brake control systems have been used in all of Boeing’s commercial aircraft that are currently in operation, and Crane enjoys an entrenched position with other key original equipment manufacturers. In the payment and merchandising technologies segment, recently acquired Crane Currency has strong relationships with over 50 mints and treasuries; the business has supplied currency paper to the U.S. Treasury for more than a century. Lastly, the fluid handling business benefits from its large installed base because customers tend to be risk-averse and often replace products like for like.
Crane generates healthy cash flows that allow it to reinvest capital in organic growth, driven by introductions of new and improved products as well as acquisitions. Although we don’t explicitly model unannounced acquisitions, we expect that Crane will continue to pursue M&A to help boost organic growth. We think future acquisitions are likely to focus on complementing the company’s existing portfolio and strengthen its core business in the fluid handling, payment and merchandising technologies, and aerospace and electronics segments.
Reputation Contributes to Moat We assign Crane a narrow moat rating. The company holds a diverse assortment of businesses, ranging from valves to vending machines to aircraft landing gear, and across its portfolio Crane benefits from customer switching costs and intangible assets. Given that many of its products are used in mission-critical applications where the margin for error is slim (for instance, brake control systems used on airplanes, advanced micro-optic security features used in banknotes, and wastewater pumps), Crane's reputation for quality and reliability is a key source of competitive advantage. Over decades, Crane has established long-lasting customer relationships and built a large installed base of equipment that generates recurring revenue from aftermarket parts and services. While we believe that the aerospace and electronics segment merits a wide moat rating, given the long-term duration of contracts that is typical in the aerospace end market, we view the remaining three segments (which compose roughly three fourths of Crane's sales) as narrow-moat businesses, resulting in a narrow moat rating for the company as a whole. Crane's narrow moat has helped it consistently generate attractive returns on invested capital, averaging roughly 14% during the last 10 years, and we think the company is well positioned to continue producing solid results.
Aerospace and electronics (24% of sales in 2019) is Crane’s most profitable segment, and we believe the unit has carved a wide moat. The cornerstones of Crane’s moat in the segment are intangible assets, as a reputation for quality and reliability is imperative to win businesses in the aerospace end market because of the inherent high cost of failure. For example, Crane manufactures sensors and landing gear that play an important role in aircraft safety. Considering that ultimately human lives are at stake, suppliers are held to the highest standards. With its strong record and decades of experience in the business, Crane enjoys strong relationships with all major original equipment manufacturers, including Boeing, Airbus, Bombardier, and Comac.
The aerospace business has high barriers to entry due to the long-term nature of business relationships. For example, after winning a contract, Crane might go through a five-year development program for a new aircraft, which will then typically run for around 20 years. Furthermore, even after the end of a run, the aircraft will continue to generate aftermarket sales for up to another 20 years. Aftermarket sales, which account for roughly one fourth of Crane’s sales in the segment, generate a relatively stable and high-margin stream of recurring revenue that helps shield the company from cyclicality. We view the aerospace and electronics segment’s moat as wide, as we believe that it would be difficult for rivals to displace Crane, considering the company’s multidecade relationships with key OEMs, large installed base of equipment, and wins on new programs.
The payment and merchandising technologies segment (35% of sales in 2019) also benefits from customer switching costs and intangible assets. Crane’s legacy business in the segment provides payment acceptance products, vending equipment, and other related solutions, while the recently acquired Crane Currency is a supplier of banknotes. The company has established a large installed base of over 15 million devices, including over 1 million vending machines and over 400,000 cashless systems installed globally.
Crane’s intangible assets in the segment include its patent portfolio, engineering capabilities, and customer relationships. The payment solutions market has high barriers to entry, given the strict requirements for banknote and coin validation. The business is technology-intensive as payment acceptance products have to immediately analyze a variety of different coins and bills (including different currencies, denominations, and designs) and maintain a high fraud detection rate. Crane is also a technology leader in merchandising systems, having introduced several innovations to vending machines, including real-time monitoring, cashless payment options, and connectivity offerings.
Crane Currency is an integrated global currency manufacturer, offering design, papermaking, security, and printing services. The business has high technology requirements, given the importance of advanced security features to deter counterfeiters. Crane Currency also benefits from customer switching costs. The business has long-standing relationships with over 50 mints and treasuries, including supplying currency paper to the U.S. Treasury for over a century. These close relationships are an advantage as Crane Currency often collaborates with central banks and is involved in early stages of designing a new banknote series, which leads to repeat business as a banknote series lifecycle can last over 10 years.
Fluid handling (34% of sales in 2019) manufactures products that often perform a mission-critical function (for example, valves used in petroleum refining, power generation, and industrial applications). Crane manufactures highly engineered valves that are designed to operate in harsh environments and handle corrosive or abrasive substances. Customers are usually risk-averse and tend to stick with the incumbent supplier because reliability and safety are paramount, and any product failures could result in costly downtime. We believe that the unit’s intangible assets, including its engineering capabilities and reputation for quality, and customer switching costs associated with its large installed base of equipment warrant a narrow moat rating.
Lastly, we think engineering materials (6% of sales in 2019) also deserves a narrow moat rating, though the moat around the business is much narrower than the moats around the other three segments. The unit manufactures fiberglass-reinforced plastic panels used in recreational vehicles, trucks, and other applications. While we don’t see evidence of customer switching costs, we think the business benefits from intangible assets and differentiates itself through product quality, new product introductions (including new colors and new formulations), and customer service. Additionally, considering Crane’s leading share in relatively small niche markets, we think new entrants would struggle to match Crane’s scale and cost efficiency to compete effectively. Although we view the business as less moaty than Crane’s other three segments, engineering materials consistently generates solid midteens operating margins, and we think the segment is more likely than not to continue outearning its cost of capital over the next 10 years.
Risks Include Economic Slowdown We assign Crane a medium fair value uncertainty rating. As a diversified industrial company, Crane is exposed to the overall health of the global economy, including a potential slowdown in industrial production and GDP growth as well as cyclicality in its end markets. Other possible negatives include cost inflation, tariffs, and research and development spending failing to generate successful new products.
Another key risk is Crane’s asbestos liability, which we estimate at around $550 million. Although the number of new claims has been steadily declining and the company has been able to settle many cases before going to trial, the uncertainty around Crane’s asbestos-related liability exposure is another source of risk.
We think Crane is on solid financial footing, which should help it weather the COVID-19 storm. Although long-term debt increased from $494 million at the end of 2017 to roughly $840 million in March 2020 following the acquisition of Crane Currency, we view the company’s financial health as satisfactory. As of April 16, Crane held $549 million in cash and had $262 million remaining available under its revolving credit line. We project the company to generate average operating cash flows of around $400 million per year over the next five years.
We estimate a debt/adjusted EBITDA ratio of roughly 2.4 times for 2020, in line with many diversified industrial peers. Debt maturities are well spread out in light of the coronavirus outbreak, with roughly $150 million due in 2020 and no debt maturities due over the next two years. Given its healthy balance sheet and solid cash flow generation, we believe that Crane is adequately capitalized to meet its upcoming debt obligations.
We expect that the company will increase the dividend roughly in line with earnings over the next five years, maintaining a payout ratio of around 25%-30%. The company has a solid record of boosting growth through M&A without eroding operating margins or returns on invested capital.