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Applied Industrial Technologies share: 20% upside potential

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Applied industrial technologies (NYSE: AIT) is one of those companies that stays behind the scenes, unlike many large, well-known companies. AIT is a mid-cap company with a market capitalization of $3.69 billion. The company is performing well with potential for strong future revenue and earnings growth. The stock has a good chance of performing well from a reasonable valuation level, as it grows at a steady pace over the long term.

The company provides a variety of products such as bearings, couplings, electric motors, filtration products, hydraulic products, pneumatic products, conveyors/handling equipment, power transmission products, paints/coatings, safety products and other equipment and tools. AIT is also an emerging supplier of robotics and machine automation, which can be a new catalyst for long-term growth.

Applied Industrial Technologies serves a wide variety of industries such as: Agriculture, Food Processing, Chemicals, Cement, Fabricated Metals, Forest Products, Industrial Machinery, Life Sciences, Mining mining, oil and gas, primary metals, technology, transportation, utilities and government. This broad coverage provides the company with long-term stability as it supports many essential functions with its products and services.

AIT distributes its industrial products in Australia, North America, Singapore and New Zealand. The company holds the No. 1 position in the industry for hydraulic power and the No. 2 position for bearings and power transmission.

Breakdown of AIT’s Business Lines

AIT categorizes 2 sectors of activity: Distribution in service centers and Fluid Power and Flow Control. Both segments posted strong double-digit sales gains in Q3FY22.

The service center-based distribution segment accounts for approximately 67% of total revenue. This segment increased its revenue by 13.6% in Q3. The Service Centers segment operates through service and distribution centers providing products for the repair/maintenance of motion control and production equipment.

The Fluid Power and Flow Control segment accounts for approximately 33% of total revenue. Fluid & Flow Control segment revenue increased 17.1% in Q3FY22. This segment includes AIT’s hydraulic, pneumatic and other flow control products.

Both segments are experiencing strong double-digit growth. This can continue as the company’s products are needed by many industries. AIT’s products are required for critical manufacturing, mining and distribution operations. The global market for electric motors is expected to grow at 6.7% annually to 2030. The global pneumatic cylinder market is expected to grow by 5.8% annually until 2030. The hydraulics market is expected to grow by approximately 4.2% annually until 2030.

Of course, the big potential driver for the future is the expected annual growth of 38% for the robotic process automation market to 2030. AIT is an emerging provider of robotics and machine automation products. It can therefore be a powerful catalyst for the company for several years.

Positive T3 results

AIT reported a 16.6% increase in net sales to $980.7 million for the quarter compared to the same period a year ago. Revenue exceeded expectations by $58.2 million. Normalized EPS rose about 20% to $1.75 from $1.46 a year ago. EPS exceeded estimates by $0.25 or 16.7%.

The company experienced strong demand which increased during the 2nd half of the quarter. AIT has seen the greatest strength in the technology, metals, mining, chemicals, utilities, building materials, freight transportation and machinery markets. The company is seeing an acceleration in demand for flow control products. There has also been some increase in demand in the natural resources and refining markets.

These results demonstrate the strength of the company in the third quarter of fiscal 22 which ended in March. AIT achieved these results even during a period of high inflation and supply chain disruptions. Another piece of good news is that AIT is seeing strong demand for its products in the last quarter of its fiscal year.

Given AIT’s strength, the company raised its current year EPS guidance to $6.15 to $6.25. This is around 6% to 8% higher than the previous range of $5.70 to $5.90. This is a positive catalyst for the title. Shares tend to rise as earnings estimates are updated, showing that the company is confident of meeting those expectations.

AIT is expected to increase revenue by 13% to 14% and profit by 29% for FY22, according to consensus estimates. If the company meets/exceeds its estimates for the fourth quarter, the next earnings report (around August 12, 2022) could be another positive catalyst for the stock.

Positioning for growth

AIT has completed four automation acquisitions over the past three years. These are expected to produce around $150 million in annual sales. This market has the highest expected growth. Therefore, this market can be a powerful growth engine for the company in the future.

Automation focuses on next-generation robotics, machine vision, and industrial networks. This must be combined with AIT’s legacy business in motion control technologies.

AIT is keeping an eye on future acquisitions to further expand automation, hydraulic power and flow control offerings. The focus is on acquiring businesses capable of producing double-digit returns on capital and improving its competitive position. AIT ultimately aims to increase its long-term growth potential.

Balance Sheet/Cash Flow/Returns

Applied Industrial Technologies has strong metrics in all areas. AIT has a strong balance sheet with 1.9 times more total assets than total liabilities and 2.8 times more current assets than current liabilities. The strong balance sheet puts the company in a good position to manage long and short term debt.

AIT’s cash flow is also strong. Over the past 12 months, AIT generated $172 million in operating cash flow and had $90 million in leveraged free cash flow and $107.8 million in free cash flow without leverage. The strong positive cash flow gives the company the ability to simultaneously invest in the business, buy back shares, pay dividends and pay down debt.

The business generates strong profitability returns. AIT has an ROE of 23%, a ROIC of 11.4% and an ROA of approximately 10%. These strong double-digit returns contribute to AIT’s above-average earnings growth.

Evaluation

AIT is reasonably priced with a forward PE of around 17 and a PEG ratio of 1.15. The PEG ratio is based on projected growth of 15% in average annual earnings over 3 to 5 years. The growth stocks I cover tend to perform well when the PEG is below 2 and when the company has positive catalysts and no significant negative catalysts, which is the case with AIT.

AIT is trading attractively below the The industrial distribution industry Forward PE of 23 and PEG ratio of 1.96. Thus, the stock has great upside potential which can be catalyzed by its strong revenue and earnings growth.

Applied Industrial Technologies AIT Stock Chart

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The weekly chart above shows the RSI above the 50 level, which is bullish. The stock price has held above the 50-day moving average and held up better than the S&P 500 (SPY) over the past 6 months. The green MACD line is roughly equal to the red signal line. The flow of money [CMF] rose from a low point towards the zero line. Wait for the green MACD line to cross above the red signal line and the CMF to cross above zero for a new uptrend to emerge.

Long-term prospects of applied industrial technologies

AIT shows strength for many of its products. I love how the company is getting into the high-growth robotics and machinery market. This market can help generate strong future growth for AIT for several years. Investors should watch for future acquisitions which may include the robotics/machinery market.

The stock’s valuation is attractive, leaving plenty of room for further price appreciation. AIT’s above-average revenue and earnings growth are positive catalysts to drive the stock higher. Analysts have a one-year price target of $122 for the stock, which is a 20% increase from the current price. This seems reasonable as it would bring the PE to around 18.7 based on an expected EPS of $6.54 for FY23.