Defense And Commercial Space Backlog Will Drive Powerful Long Term Upside Potential

Catalysts

About Graham

Graham Corporation provides highly engineered, mission-critical equipment and systems for defense, space, energy and advanced industrial applications.

What are the underlying business or industry changes driving this perspective?

• Record $500 million backlog, with 35 to 40 percent expected to convert in the next 12 months and a multiyear book-to-bill profile above one times, supports sustained revenue growth and enhances earnings visibility.
• Expanding role on U.S. Navy and related defense programs, reinforced by the new advanced manufacturing facility and long duration modernization initiatives, should drive higher volumes and better fixed cost absorption, supporting net margin expansion.
• Rapidly growing commercial space launch activity, evidenced by new multi-customer turbomachinery awards and specialized test infrastructure coming online, positions Graham to benefit from increasing launch cadence and orbital infrastructure build-out, lifting revenue and EBITDA.
• Early mover position in small modular nuclear reactors and cryogenic applications, backed by proven rotating equipment expertise, provides exposure to a long runway of clean energy deployment, supporting high margin engineered product revenue over time.
• Technology focused M&A, including the Xdot Bearing Technologies acquisition and integrated foil bearing capability, broadens proprietary content in high-speed systems, enabling premium pricing, higher contribution margins and long-term earnings growth.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more optimistic perspective on Graham compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming Graham's revenue will grow by 13.8% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 5.1% today to 9.3% in 3 years time.
• The bullish analysts expect earnings to reach $33.5 million (and earnings per share of $2.85) by about July 2029, up from $12.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 72.4x on those 2029 earnings, down from 99.3x today. This future PE is greater than the current PE for the US Machinery industry at 27.5x.
• The bullish analysts expect the number of shares outstanding to grow by 6.52% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.35%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The company is increasingly concentrated in long cycle defense programs, with roughly 85 percent of the record backlog tied to the defense market, so any shift in U.S. defense priorities, budget pressure or program delays could lead to order cancellations or slower awards, which would pressure revenue and earnings growth over the long term.
• Secular growth expectations in commercial space and small modular nuclear reactors rely on markets that are still early in commercialization and historically prone to program setbacks and funding pauses. Slower than anticipated industry adoption could leave new capacity underutilized and weigh on net margins and EBITDA.
• Management is investing heavily in new advanced manufacturing, cryogenic test infrastructure and additional machining centers based on current demand. However, if the multi year order momentum moderates or book to bill falls closer to the low end of its historic range, fixed costs could rise faster than volumes, compressing gross margin and limiting earnings expansion.
• The long term strategy depends on technology focused M&A and integration of assets like Barber Nichols and Xdot Bearing Technologies. Any difficulty in integrating teams, realizing 20 percent plus ROIC on projects or defending proprietary content against competitors could dilute returns, restraining earnings and return on invested capital.
• The business is exposed to external cost and policy headwinds, evidenced by up to 4 million dollars in annual tariffs and reliance on favorable contract language. If trade conditions, tariffs or supply chain costs worsen faster than pricing can be reset, gross profit and net margins could deteriorate despite healthy backlog.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for Graham is $135.0, which represents up to two standard deviations above the consensus price target of $130.75. This valuation is based on what can be assumed as the expectations of Graham's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2029, revenues will be $361.9 million, earnings will come to $33.5 million, and it would be trading on a PE ratio of 72.4x, assuming you use a discount rate of 8.4%.
• Given the current share price of $106.12, the analyst price target of $135.0 is 21.4% 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.