Accelleron’s Stock Surge Drives It Into Overvalued Territory (ACLLY)

We started covering Accelleron Industries (OTCPK:ACLLY) even before its spin-off from ABB (OTCPK:ABBNY) and when it started trading, we remarked it was off to a good start, noting that we particularly liked the services segment because of its resilient recurring revenue. However, in our last article, we downgraded the company as we thought the valuation had gotten relatively high. We were clearly too early with our downgrade, as shares have outperformed the S&P 500 index (SPY) and gained roughly 36% in about four months, despite there being no major news coming out from the company. Finally, a major update came on March 27th, when the company published its 2023 results. We are revisiting our analysis based on the recently published results, and the now much higher valuation.

Fiscal Year 2023 Results

Results were solid, but we do not think they justify the kind of price appreciation seen in the shares the last few months. Organic revenue increased ~15.5%, mostly through price increases to compensate some of the inflation seen in its input costs. While it is good to see that the company has the pricing power to protect its profit margins, we would caution investors not to count on this level of revenue growth going forward, as it will get harder to justify to customers any future significant price increases. We believe volume growth is more durable growth, and in that respect, performance was basically flat.

The company did do a good job further increasing its free cash flow conversion to 99%, which enabled a dividend increase.

While operational EBITA saw a corresponding increase, net income was actually lower due to one-time costs, mostly related to the company’s separation and set up as an independent entity. Free cash flow was also helped by changes in working capital, and a higher depreciation and amortization amount.

It is important to note that given the reduced net income, the dividend payout ratio increased to 93% of reported net income after minority interests. We expect net income to rebound in 2024, given the operational EBITA improvement and the fact that the one-time costs should no longer impact the bottom line. Still, we think the payout ratio will remain high, and investors should not expect much dividend growth longer term.

Balance Sheet

Accelleron Industries remains committed to a solid balance sheet, and so far it has maintained very decent leverage. Net debt to operational EBITDA ticked up due to the OMT acquisition but remains at a very healthy ~1x leverage ratio. The elevated cash holdings also give the company optionality to pursue some additional bolt-on acquisitions if the opportunity presents itself.

Research & Development

We like that the company continues to spend money on research and development, in particular, to have solutions ready for coming emissions requirements that its customers will soon be facing. It is also further improving the performance of its turbochargers, which are already some of the best performing.

This is important, as it is a signal that the company still sees some growth opportunities, even if the future could be very challenging for them if the world goes fully electric. In the meantime, the company is seeing some tailwinds from increased demand from data centers (for their backup power generators), and from new more sustainable fuels in the shipping industry.

Outlook

In the medium term, there are some tailwinds that can provide growth opportunities for the company, including strong data center growth many of which use turbochargers for their emergency backup power generators. The company is also benefiting from some hard-to-decarbonize sectors, such as shipping, where stricter regulations are pushing shipowners to order dual-fuel vessels.

These dual fuel engines have a positive impact on Accelleron given that they require a higher amount and more advanced fuel injectors, and the demanded increased efficiency and fuel flexibility requirements make adding turbochargers more attractive, and in some cases even essential. Despite these tailwinds, the mid-term organic growth target is not particularly attractive at only 2% to 4%. Longer-term we believe the company might even experience negative growth if sectors like shipping start electrifying.

Valuation

Most of the price appreciation has clearly been the result of multiple expansion, and we have a hard time understanding why investors would be willing to pay technology company multiples for an industrial business with relatively poor growth prospects.

We find the recent run-up in price of the last 3-4 months particularly difficult to explain, as there were no major developments from the company during this period.

Given the poor mid-term growth prospects of 2% to 4% organic growth, combined with a price to cash flow from operations above 30x, we are further downgrading the shares to “Strong Sell”.

With the company paying out most of its earnings as dividends, and the forward dividend yield currently at ~2.5%, we do not see much to get excited about. The dividend yield is low and given the high payout ratio and low organic growth, the prospects of seeing the dividend grow meaningfully going forward are not great.

Risks

We see two major risks for Accelleron Industries investors, one is the elevated valuation for an industrial company with mediocre growth prospects. The second is perhaps ten or twenty years ahead, but we do believe that even industries like shipping will eventually electrify. Battery costs continue to see significant price declines and performance improvements. It is therefore only a matter of time for electric ships to become a reality. The question is mostly when, not if, and that is why we believe investors should pay a low multiple for the business.

Conclusion

After reviewing full year 2023 results for Accelleron Industries, we are downgrading our rating to “Strong Sell”. Financial performance was not particularly bad, and we did not find anything particularly troubling with the results. It is simply a matter of valuation multiples expanding, while business results clearly do not warrant such increases. The company is already paying out most of its earnings as dividends, the dividend yield is relatively low, and we do not see much room for dividend growth in the future.

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