Plunging boldly into the world of sawdust and timber, Alamo Group (ALG 1.04%) spent a solid chunk of cash in late October 2019 acquiring Morbark Holdings Group, LLC, a forestry equipment manufacturer. The largest of three purchases during 2019, Alamo Group’s acquisition of Morbark added a new sector to its existing line of municipal cleanup and maintenance vehicles.
The company’s recently released Form 8-K/A filing with the SEC reveals several important details about Morbark’s financial health and overall viability. This data allows a better assessment regarding whether Alamo’s acquisition was in fact a positive for people investing in stocks in the industrial sector. Shortly after the acquisition, Alamo’s stock jumped to approximately $129 per share, then fell almost immediately to $107 a share. The price rebounded steadily to roughly $130 per share currently, raising the question of whether it can go higher.
Background -- the acquisition
Alamo spent $325 million sealing the deal with Morbark, diversifying its product lines into a fresh field of industrial manufacture. Morbark fabricates a variety of forestry-related equipment, including everything from chippers and flails to help manage biomass and forest health, to highly maneuverable wheel loaders useful for logging in rugged terrain.
According to the Food and Agriculture Organization, harvesting and sale of wood products has reached its highest level since monitoring began in 1947. Wood product trade jumped 11% between 2017 and 2019 alone, driving demand for machinery to extract timber for industrial use. Wood pellet production grew by a similar amount in just one year to meet mounting bioenergy quotas. Pellet demand fits neatly with Morbark’s drum chippers and similar equipment, which turn branches and other wood smaller than sawtimber into salable chips or sawdust.
Image source: Morbark
While Alamo’s purchase of Morbark positioned it to profit from several rapidly growing markets, the acquisition had a potential downside. Alamo’s Q3 2019 results reported a 6.3% year-over-year drop in net income, despite an 8.8% jump in net sales. The Q3 report ascribes this decline directly to the acquisition of Morbark, along with two smaller companies, Dixie Chopper and Dutch Power.
Three takeaways from Morbark's fundamentals
In order to help assess whether the hit to Alamo’s net income in 2019 was worth it in terms of potential gains to future growth and share value, a closer look at the company’s SEC filings and other data reveals several important facts.
First: Morbark’s net margin beats Alamo’s
Morbark’s balance sheet shows that, in the first 9 months of 2019, it converted sales into profits with nearly twice the efficiency of Alamo. Morbark’s net sales of $189.6 million and net income of $22.7 million during the period gave it an approximate 11.98% net margin, compared to Alamo’s 6.51% net margin ($818.9 million net sales, $53.3 million net income).
Morbark’s net margin also outperformed the industrial machinery sector’s historical average 8.14% net margin, and slightly betters the 11.67% Q4 2019 net margin for the sector. Clearly, Morbark is operating more effectively than Alamo Group at generating profits and should help to raise the combined entity’s profitability.
Second: Morbark’s debt-to-equity ratio is comparable to Alamo’s
While the comparison is inexact because Alamo Group is a publicly traded stock and Morbark is not, measuring liabilities and equity between the two shows very close equivalence. Morbark’s current 36.2% D/E ratio on approximately $33.78 million in liabilities and $93.25 million in members’ equity is higher than Alamo’s current 27.1% D/E ratio, but Alamo’s debt-to-equity ran as high as 34.5% in March 2019 and peaked at 63.3% historically. Both are within or nearly within the 30% D/E ratio that generally indicates good solvency and stability, so Morbark will not significantly alter Alamo’s liability situation.
Third: Morbark is moving product faster than Alamo
While Alamo is obviously selling more overall than Morbark, the acquired company’s inventory tells an interesting story when compared to Alamo Group’s. During the first 9 months of 2019, Alamo Group’s net inventory increased by $29.8 million. Over that same period, the raw materials in Alamo’s inventory declined from $14.6 to $14.1 million, while finished goods rose from $149.2 million to $173.9 million. Alamo is building street sweepers and other municipal maintenance vehicles considerably faster than it can sell them, according to its Q3 2019 Form 10-Q quarterly report to the SEC.
Morbark, on the other hand, had a negative net $4.1 million inventory change over the same period, with ending inventories of $66.1 million. While the net decline in inventory isn’t huge, it demonstrates potentially increasing demand for Morbark’s forestry equipment, where demand for Alamo’s core products may be softening.
Alamo’s forestry equipment acquisition may be solid as an oak
Overall, then, multiple factors point towards Alamo’s Morbark acquisition as a solid move. To recap, Morbark is positioned in the rapidly expanding forestry equipment industry, sustained by fast-growing demand for both timber and wood pellets for bioenergy. Its fundamentals equal or better Alamo’s own in several key areas, including a much better net margin, comparable debt-to-equity that won’t negatively impact Alamo’s liabilities, while inventory data suggests faster-growing demand than Alamo enjoys.
Alamo Group appears to have added a high-speed, low-drag company to its operation, one which should help it grow in the energetic forestry machine sector. Diversifying and putting down roots in this fresh market with a quality acquisition definitely justifies its current share price, in my opinion, and will likely lead to higher share prices in the near future.
