US Navy Contracts And Energy Transition Will Unlock Lasting Potential

Key Takeaways

• Strong recurring revenue from defense and energy drives stability, while new energy transition markets offer significant long-term growth potential.
  
• Investments in automation, proprietary products, and enhanced services are expected to boost margins, competitive positioning, and operational efficiency.
  
• Heavy dependence on volatile defense and legacy energy markets, coupled with uncertain new ventures and operational execution risks, threatens future revenue stability, growth, and profitability.

Catalysts

Designs and manufactures fluid, power, heat transfer, and vacuum technologies for chemical and petrochemical processing, defense, space, petroleum refining, cryogenic, and energy industries.

• Record backlog growth and strong book-to-bill ratio signal rising multi-year demand, underpinned by sustained U.S. Navy defense programs and increasing global infrastructure investment, supporting future revenue visibility and stability.
  
• Major growth initiatives in energy transition markets-such as small modular nuclear reactors, hydrogen, and cryogenics-position Graham to benefit from long-term shifts toward renewables, potentially driving new orders and incremental revenue growth.
  
• Strategic investments in manufacturing automation, new facilities, and ERP systems are set to enhance operational efficiency and throughput, which should drive margin expansion and higher earnings over time.
  
• An expanding aftermarket and service business, especially in both energy and defense markets, is increasing recurring, higher-margin revenue streams, expected to improve gross and net margins and reduce earnings volatility.
  
• Enhanced R&D and proprietary product offerings (e.g., the next-gen vacuum distillation nozzle) differentiate Graham in increasingly complex process industries, supporting pricing power and long-term margin improvement.

Graham Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Graham's revenue will grow by 9.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 6.4% today to 8.5% in 3 years time.
• Analysts expect earnings to reach $24.0 million (and earnings per share of $2.1) by about August 2028, up from $13.9 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 34.3x on those 2028 earnings, down from 41.1x today. This future PE is greater than the current PE for the US Machinery industry at 23.8x.
• Analysts expect the number of shares outstanding to grow by 0.78% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.93%, as per the Simply Wall St company report.

Graham Future Earnings Per Share Growth

Risks

• The company's record backlog and near-term revenue strength are heavily concentrated in multi-year, lumpy U.S. defense contracts-creating future risk if Navy procurement slows, projects are delayed, or government budgets change, which could significantly impact revenue stability and growth.
  
• Graham's energy and process segment continues to rely meaningfully on oil refining and petrochemical markets; ongoing global energy transition away from fossil fuels and toward renewables may structurally reduce long-term demand for their core legacy products, impacting future revenue growth opportunities and earnings.
  
• The strong gross margin performance in the most recent quarter was driven unusually high aftermarket sales, which management does not expect to be sustainable, and the mix is expected to normalize with more lower-margin project work, potentially pressuring future margins and net income.
  
• Growth in new markets like small modular nuclear, cryogenics, and space is in early-stage, low-volume development phases, with management noting commercial traction remains nascent; if industry adoption is slower or more competitive than anticipated, Graham could see delayed or lower-than-expected revenue and earnings contribution from these initiatives.
  
• Execution risks include potential difficulties integrating recent/acquired facilities, completing automation and ERP rollouts, and launching new testing capacity; failure to realize anticipated productivity and margin enhancement from these capital projects could result in elevated SG&A or underutilized assets, diminishing net margins and returns on invested capital.

Valuation

• The analysts have a consensus price target of $59.5 for Graham based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $65.0, and the most bearish reporting a price target of just $52.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $281.8 million, earnings will come to $24.0 million, and it would be trading on a PE ratio of 34.3x, assuming you use a discount rate of 7.9%.
• Given the current share price of $51.89, the analyst price target of $59.5 is 12.8% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.