New Facilities And Backlog Will Strengthen Future Presence In Defense Sector

Key Takeaways

• New facilities and testing capabilities will enhance Graham's manufacturing capacity and attract defense and space contracts, boosting future revenue growth.
  
• Strategic initiatives like operational improvements, strong talent integration, and a substantial defense backlog support sustained revenue and earnings growth.
  
• Graham's heavy reliance on defense orders and increased expenses may challenge revenue stability and margins if strategic investments and market conditions don't yield expected returns.

Catalysts

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

• The construction of a new Batavia manufacturing facility, scheduled for completion in June 2025, will enhance Graham's manufacturing capacity, particularly for naval defense work, potentially boosting revenue from increased defense contracts.
  
• The upcoming cryogenic propellant test facility, set to begin initial testing by mid-2025, will provide scalable testing solutions for critical programs, likely contributing to future revenue growth as it attracts space, defense, and new energy sectors.
  
• Graham's focus on operational improvement initiatives and expansion of R&D investments, including projects with over 20% ROI, is expected to impact their earnings by driving efficiency and innovation, potentially increasing net margins.
  
• The successful integration and growth of Barber-Nichols, led by new leadership, demonstrates Graham’s capacity to develop internal talent and execute strategic plans, which may positively influence future earnings and revenue growth.
  
• The strong backlog of $385 million, with 80% anchored in defense and anticipated conversions of 45-50% to sales within 12 months, provides stability and visibility into future revenue, supporting projections for sustained growth.

Graham Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Graham's revenue will grow by 9.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 4.6% today to 8.3% in 3 years time.
• Analysts expect earnings to reach $21.9 million (and earnings per share of $2.08) by about March 2028, up from $9.2 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 32.5x on those 2028 earnings, down from 37.2x today. This future PE is greater than the current PE for the US Machinery industry at 21.4x.
• Analysts expect the number of shares outstanding to grow by 0.3% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.17%, as per the Simply Wall St company report.

Graham Future Earnings Per Share Growth

Risks

• The significant lumpiness in order flow, especially within the defense sector, can lead to unpredictable and inconsistent revenue across quarters. This volatility may challenge the visibility and planning of future revenues and earnings.
  
• Graham's reliance on defense orders, which make up a significant portion of their backlog, could be negatively impacted by defense budget fluctuations, potential sequestration, or a continuing resolution, thereby affecting future revenue stability.
  
• The decline in refining revenue due to timing issues highlights potential vulnerabilities in other segments, where similar timing and cyclical challenges could impact overall revenue growth.
  
• Increased SG&A expenses, driven by strategic investments in technology and a new ERP system, coupled with the cost of acquisitions such as P3 Technologies, may pressure net margins if revenue growth does not adequately offset these rising expenses.
  
• The expanding capital expenditure commitments, necessary for broadening capabilities and capacity, pose a risk of overextension, potentially impacting the company's balance sheet if anticipated returns on investment do not materialize as planned.

Valuation

• The analysts have a consensus price target of $52.667 for Graham based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $263.3 million, earnings will come to $21.9 million, and it would be trading on a PE ratio of 32.5x, assuming you use a discount rate of 7.2%.
• Given the current share price of $31.33, the analyst price target of $52.67 is 40.5% 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.