Sector Watch: Supplier consolidation stocks
In the past, industrial customers maintained broad supply chains, contracting with numerous local distributors. This method is changing, though. Motivated by the need to reduce costs and improve inventory turns, most industrial customers are consolidating their supply chains and relying on first-tier distributors that can provide one-stop shopping. These customers are also demanding value-added services such as integrated supply, system design, and equipment fabrication, installation and maintenance.
This supplier consolidation is creating budding opportunities for DXP Enterprises, Inc. (Nasdaq: DXPE) a leading U.S. supplier of maintenance, repair and operations (MRO) services, and KHD Humboldt Wedag International, Ltd. (NYSE: KHD), a global provider of plant design and equipment procurement services.
KHD Humboldt provides industrial plant engineering services and equipment to mineral processors. It is a leading supplier to the global cement-manufacturing market and offers its customers proprietary technologies, plant and equipment design, and customized systems for process control and equipment optimization.
Formerly a merchant bank, KHD shifted its focus to industrial plant engineering in 2006. Since then, it has established operations in India, China, Russia, Germany, the Middle East, South Africa and the United States.
During the first nine months of 2007, KHD’s revenues grew 75% year-over-year to $418.8 million from $239.6 million and income from continuing operations climbed 102% to $38.6 million, or $1.27 per share, from $19 million, or $0.63 per share. New orders rose 123% in the September quarter to $240 million and exceeded $569 million for the nine-month period. Backlog totaled $762 million; nearly 90% of backlog was contracts in China, India, Russia and other emerging economies. KHD expects a 70% increase in full-year 2007 earnings to be between $1.70 and $1.75 per share.
In December, KHD announced a contract with the Baltic Region’s largest cement producer for a production line capable of producing 4,500 tons of dry cement per day. This contract includes engineering, design and equipment supply and is valued at $51 million. KHD also announced new contracts valued at $177 million total for cement plants in Egypt and India.
KHD began trading on the New York Stock Exchange last September. Consensus estimates look for 19% growth next year and longer-term growth averaging 35% annually. My $35 price target for KHD is higher than Tuesday’s closing price of $24.83. Over the last 52 weeks, shares have ranged between $18 and $45.74.
DXP Enterprises supplies MRO services and equipment to over 35,000 industrial customers. Its MRO business serves the fluid handling, bearings, power transmission, general mill, safety supply and electrical products markets. The company also sells wire conduit, wiring devices, electrical fittings and related electrical products through its electrical contractor segment. Competitive strengths include industry-leading expertise in pumps, bearings, power transmission systems and electrical supplies as well as broad product lines that position DXP as a single-source supplier.
The company operates 98 service centers nationwide, supplied by 74 supply chain service locations, three regional distribution centers and five fabrication facilities. Customers include Chevron Phillips, Baker Hughes Incorporated (NYSE: BHI), Exxon Mobil Corporation (NYSE: XOM), FMC Corporation (NYSE: FMC), Huntsman Corporation (NYSE: HUN), Firestone, Shell, The Dow Chemical Company (NYSE: DOW), Schlumberger Limited (NYSE: SLB) and other Fortune 500 names.
Management estimates the company’s end-markets address a $250 billion opportunity. DXP is solidifying its position as a tier-one supplier through acquisitions. In September, it acquired Precision Industries, a leading national supply chain service provider. Precision generates annual revenues exceeding $250 million and counts Avery Dennison Corporation (NYSE: AVY), The Coca-Cola Company (NYSE: KO), ConAgra Foods, Inc. (NYSE: CAG), The Goodyear Tire & Rubber Company (NYSE: GT), Navistar International Corporation (OTC: NAVZ) and Whirlpool Corporation (NYSE: WHR) among its customers. The February 2008 acquisition of Rocky Mountain Supply, Inc. expands its bearings and power transmission product lines and extends its geographic coverage in the Rocky Mountain region,
DXP’s sales increased 38% year-over-year in the first nine months of 2007 to $275.7 million from $200.5 million. Acquired businesses contributed $52 million of the sales gain and organic sales improved 12% year-over-year. Earnings also rose 38% to $11.6 million, or $1.86 per share, from $8.4 million, or $1.47 per share. Analysts forecast 28% growth in 2007 EPS to $2.67 and look for growth averaging 25% annually over the next five years. Last year these shares traded as high as $54. My $45 price target for DXP (DXPE) is above the current closing price of $35.78 on Tuesday. Shares for the company have ranged between $28.21 and $53.88 over the past 52 weeks.
Note: For more on DXP, see DXP Enterprises, Inc.: Time tested, Feb. 6, 2007.
