By: Scott Davis
It’s unusual for us to make a negative stock call in the midst of an industrial upcycle, particularly for a company as cyclical as CFX. The stock has rebounded modestly after several tough quarters and sentiment appears to be improving with several recent sell-side upgrades. However, despite what should be a favorable macro environment, CFX’s cash flow and earnings quality continues to deteriorate, making it an outlier in our coverage. While the FabTech welding business has turned the corner, the Howden air handling (i.e. fans/compressors) business continues to struggle and is dragging down results. We think problems here run deeper than many appreciate and will likely take more time than expected to fix. Cash shortfalls and already elevated leverage at 2x also makes large scale M&A increasingly less likely; something the stock appears to be discounting, and a key tenet of the bull case. As a result, we are downgrading the stock to Underweight from Equal Weight. We are also reducing our 2-year price target to $36 (14x our 2020 cash EPS of $2.60) from $40 (15x our prior 2020 cash EPS of $2.65), implying a flattish stock vs. upside for the rest of the group.