Accelerated Growth From New Technologies And Sustainability Efforts, Amidst Shrinking Margins And Execution Risks

Key Takeaways

• Strategic initiatives, including focus on sustainability and advanced technology in products, aim to boost long-term revenue and strengthen the brand.
  
• Aggressive pricing and increased production capacity for innovative products are designed to enhance market position and drive sales growth.
  
• Tennant faces challenges from macro-economic issues, market conditions in APAC, reliance on new technologies, ERP upgrades, and acquisition integration risks, impacting revenue and costs.

Catalysts

Designs, manufactures, and markets floor cleaning equipment in the Americas, Europe, the Middle East, Africa, and the Asia Pacific.

• Continued strong order demand and backlog benefits indicate potential for accelerated revenue growth in the second half of 2024 and beyond, possibly leading to higher net sales and improved earnings before interest, taxes, depreciation, and amortization (EBITDA).
  
• Pricing strategy focusing on capturing value through 50 to 100 basis points of annual price growth could enhance revenue and net margins by leveraging market position across key geographies.
  
• Increased manufacturing capacity for the X4 ROVR, a new autonomous floor-cleaning machine, due to robust customer interest, may drive revenue growth through new product sales, impacting both top-line growth and future market share expansion.
  
• Strategic acquisitions and investment in Brain Corp for exclusive access to Gen 3 technology highlight a focused M&A strategy, potentially contributing to growth in core businesses, driving value through connected autonomy, and expanding margins through efficient capital allocation.
  
• Commitment to sustainability through initiatives like sourcing 92% of electricity from renewable sources and achieving a 13% reduction in scope 1 and 2 greenhouse gas emissions could enhance operational efficiencies, reduce costs in the long term, and appeal to increasingly eco-conscious consumers and businesses, indirectly supporting revenue growth and brand strength.

Assumptions

• Analysts are assuming Tennant's revenue will grow by 4.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 8.8% today to 6.6% in 3 years time.
• Analysts expect earnings to reach $95.5 million (and earnings per share of $4.75) by about October 2027, down from $110.2 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 32.9x on those 2027 earnings, up from 16.0x today. This future PE is greater than the current PE for the US Machinery industry at 21.7x.
• Analysts expect the number of shares outstanding to grow by 2.05% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.89%, as per the Simply Wall St company report.

Risks

• Macro-economic challenges and sluggish demand in the EMEA region may negatively impact revenue growth and margin expansion due to volume declines and flat sales, particularly in the industrial equipment segment.
  
• Worsening market conditions in APAC, especially in China and Australia, due to decreasing demand and government-induced overproduction, could lead to further pressures on pricing and margins, affecting overall net sales and profitability in the region.
  
• Dependence on new product development and AMR technology, while a growth driver, presents execution risk if the anticipated demand does not materialize or if technical challenges arise, potentially impacting revenue growth and R&D costs.
  
• The ERP modernization effort, while necessary for long-term efficiency, entails significant upfront costs and execution risks that could impact short-term operating expenses and cash flow, potentially affecting net income in the near term.
  
• Strategic acquisitions and investments, such as in Brain Corp and TCS, carry integration risks and may not deliver the expected return on investment, potentially impacting earnings and cash flow if these initiatives do not achieve anticipated synergies or market growth.

Valuation

• The analysts have a consensus price target of $128.5 for Tennant 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 2027, revenues will be $1.4 billion, earnings will come to $95.5 million, and it would be trading on a PE ratio of 32.9x, assuming you use a discount rate of 6.9%.
• Given the current share price of $93.37, the analyst's price target of $128.5 is 27.3% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• 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.