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Introduction
Our most recent comment on HillenbrandInc. (NYSE:HI) it was in March 2023 when we highlighted how the industrial player continued to invest in growing markets. Due to significant technical resistance in overheads and lower future growth projections in time; however, we have maintained our “Hold” rating on the stock. Shares are down just over 4% over the past 15 months or so as sustained consolidation continues, as we see below.
However, if we quickly move on to Hillenbrand’s most recent quarterly earnings set (Second Quarter FY 2024 Results) which were announced last April 30, we see that the company missed its GAAP estimate ($0.09 EPS) by a wide margin while also missing its final estimate. Additionally, the lowered outlook for the earnings announcement, from both a revenue and earnings perspective, means that Hillenbrand’s 10-week moving average has moved higher. has declined and is now on track to fall below its 40-week counterpart.
Suffice it to say, if an intermediate bearish crossover were to materialize here in the near term, shares could easily fall back quickly to long-term support below the $37 level before finding support again. Additionally, the amount of space below the $37 level, coupled with the MACD indicator’s bearish divergence, demonstrates that there is real downside risk if an underlying downtrend gains traction. Therefore, we recommend that investors continue to observe Hillenbrand’s technical data in the event of a significant short-term trend change. Below are some concerning fundamental trends from the recent second quarter earnings report, which validate a cautious stance at this time.
Intermediate techniques Hillenbrand (Stockcharts.com)
Capital must be returned more quickly
The most concerning trend from the company’s recent second quarter report is the fact that volume trends continue to be hampered by increasing macroeconomic uncertainty. Remember, to increase return on capital over time, Hillenbrand must either increase profit margins or increase volumes. Today, profit margins remain historically depressed, as the company’s net profit margin of 2.79% continues to be lower than its 5-year average of 7.53%. To combat this, management had to cut costs across all its businesses to protect the bottom line. This can help in the short term, but a company’s cost-cutting initiatives are always limited. In fact, management intended that some costs would likely return to the income statement when volume trends return in earnest, as we see below.
In response, we began implementing cost reduction measures during the quarter, including targeted restructuring and strict limitations on hiring, travel and other discretionary costs. I am pleased with the urgency with which the teams implemented these actions which continue to contribute to the 100 basis point increase in adjusted EBITDA margin we saw during the quarter. Although we expect some of these costs to return, we will remain disciplined until orders return to expected levels.
Declining organic volumes coupled with low margins has become a serious proposition for Hillenbrand as it affects financials in the following ways. Due to weak working capital constraints, where accounts receivable (over $678 million) continue to grow at a worrying rate, the ripple effect is that Hillenbrand continues to struggle to muster enough cash to cope with your debt. Long-term debt has now passed the $2 billion mark, with interest costs totaling almost $100 million over the past 12 months. I repeat, these unfavorable trends all come from negative trends in organic volumes, where growth is not being channeled sufficiently across the business to offset the costs involved.
Persistent headwinds for MTS
Although the FPS acquisition boosted sales in Hillenbrand’s Advanced Process Solutions segment in the second quarter, the performance of the smaller MTS segment continues to disappoint. Due to the prolonged absence of customer-driven demand, management made the decision last quarter to launch a restructuring program aimed at essentially “righting the ship” until demand returned somewhat. This will cause near-term pain (highlighted by the $25 million restructuring charge in the second quarter) before significant savings can be realized. However, the concern here, from a forward-looking perspective, is that the company’s continued slow short cycle hot channel offerings (which are higher margin products) continue to negatively affect MTS’s mix , therefore doing nothing to increase profits in this segment. This unfavorable trend stems from continued weakness in the electronics and consumer goods sector, primarily in the North American market. Additionally, this trend is compounded by persistent inefficiencies in a specific hot location, further derailing margins.
Free cash flow down
While profitability, as mentioned, remains a real concern in the MTS segment, Hillenbrand’s APS segment (despite inorganic gains resulting from FPS) continues to suffer from below-average order counts, primarily in the midsized. Free cash flow for the year is estimated at $140 million, well down from the previous estimate of $230 million. This means (based on management’s updated FCF estimate) that shares are trading with a forward free cash flow multiple of around 22, but the real issue regarding cash flow development of the company is as follows.
With debt reduction being management’s top priority and over $60 million continuing to be paid out in dividends, there is cause for concern about how future expenses will be financed. Although Hillenbrand reported more than $224 million in cash and equivalents on the balance sheet at the end of the second quarter, recent acquisitions have pushed Hillenbrand’s goodwill above the $2 billion mark on the balance sheet. Suffice it to say that, with many risks remaining on the table regarding possible future impairment charges derived from recent transactions, more aggressive spending does not appear likely at Hillenbrand at this time. Therefore, being an acquisitive company, it will be interesting to see how the market digests this trend over time.
Conclusion
In summary, even though we reiterate our “Hold” rating on Hillenbrand, we keep our eyes glued to the technical aspects to see if indeed a bearish intermediate crossover will take place in the short term. Reduced volume trends in “advanced process solutions”, growing short interestt, profitability MTS’ woes and lowered outlook for fiscal 2024 demonstrate that investors need to remain cautious in this area. We look forward to continued coverage.
