PAR reports solid 3Q 2024 results with ~25% organic ARR growth and the achievement of adj. EBITDA positivity; closed the sale of Rome Research during the quarter, which completes the divestiture of PAR Government resulting in the company becoming a pure-play restaurant technology platform; close coverage, as of today’s market bell

• This morning, before the market open, PAR reported ~41% top-line growth to ~$96.8 million (compared with consensus of ~$92.1 million), including ~25% organic annual recurring revenue (ARR) growth (which, on annualized basis, now stands at ~$248 million).  More importantly, the company achieved a key milestone/inflection point in its journey to profitability by generating adj. EBITDA of $2.4 million (as compared with a $6.6 million loss in the prior period and consensus of $0.6 million) in 3Q 2024.  Adjusted EPS improved to a loss of $0.09 (from a $0.35 loss in 3Q 2023 and the consensus loss forecast of $0.21).
• Notably, the company also closed the sale of Rome Research Corp. (announced in June 2024 along with the sale the sale of its PGSC to Booz Allen Hamilton), which completes the divestiture of PAR’s Government segment.
• In that context, with shares trading toward the higher-end of our bull/bear valuation scenarios in today’s trading (see Exhibit #1 on page 2) and the company’s transformation into a pure-play restaurant technology platform now complete we prefer to maintain a disciplined approach and focus our attention on names that better fit our broader “value plus catalyst” approach. 
• As such, we will close coverage of PAR Technology Corp. (PAR), as of today’s market close.
• For context, shares of PAR have appreciated ~41% (outperforming the S&P 500 by ~10% and the Russell 2000 by ~29.5%) since our initial recommendation in December 2021. 

PCS Research Group welcomes and encourages your feedback.  Please feel free to call us if we can be of service.

MASI posts modest 3Q 2024 beat and full-year EPS guide increase as the company renews focuses on profitability; the strategic review of the Non-Healthcare/Consumer business as well as the search for a permanent CEO remain on-going; fair value increased to $158 per share

Last night, after the market close, MASI posted 3Q 2024 consolidated sales up nearly 5.5% to ~$504.6 million (compared with consensus of $502.9 million and guidance of $495-$515 million) with adjusted EPS growth of ~30.5% to $0.98 (compared with consensus of $0.82 and guidance of $0.81-$0.86).

By segment, Healthcare segment sales rose 11.5% to $343.3 million (versus guidance of $335-$345 million) with gross margin expansion of 260 bps to 62.9% while Non-Healthcare segment sales declined ~6% to ~$161 million (versus with guidance of $160-$170 million) offset by gross margin expansion of 200 bps to 34.6%.

In terms of guidance, the company tightened its full-year consolidated top-line outlook to $2.075-$2.105 billion (from $2.085-$2.135 billion), reflecting Healthcare sales up ~9%-10% to $1.39-$1.4 billion (previously $1.385-$1.405 billion) and Non-Healthcare sales down 8.5%-11.5% to $685-$705 million (previously $700-$730 million), while increasing its full-year adj. operating income and EPS outlooks to $325-$336 million and $3.95-$4.10 (up from $317-$330 million and $3.80-$4.00, respectively).

For 4Q 2024 specifically, MASI projects consolidated sales of $581-$611 million, reflecting Healthcare revenue of $363-$373 million and Non-Healthcare sales of $103-$114 million, with adj. EPS of $1.35-$1.50.

Looking to 2025E, without providing specific guidance, management anecdotally noted (for modeling purposes) that it could be reasonable to expect an operating margin profile of “at least 26%” at Healthcare along with an effective tax rate of ~26% and a diluted share count of ~55 million.

Longer-term, MASI has laid out plans to potentially double its earnings power (to ~$8.00 per share) over the next five years.

In regard to the on-going strategic review of the Non-Healthcare/Consumer business, disclosed in late-March 2024, management indicates the process is “progressing” and it continues to evaluate a range of options (e.g., spin-off, sale or joint venture).  Also, the company continues its search for a permanent chief executive with the help of Korn Ferry and is evaluating both internal and external candidates.  The company did not commit to any timelines on either front but indicated they were both a “priority” for the Board. 

Recall that following the successful proxy battle waged by Politan Capital Management leading to its effective “takeover” of MASI’s Board the company’s founder & long-time CEO Joe Kiani resigned. More recently, MASI announced that on the advice of outside counsel Mr. Kiani was terminated (with cause) for allegedly attempting to manipulate the shareholder vote via an “empty voting” scheme with RTW Investments.  Clearly, this situation is likely to play out in court, but we would note that a potential legal victory could allow the company to avoid certain aspects of Mr. Kiani’s employment agreement, most notably the payout of 2.7 million restricted shares (potentially more than $400 million at current price levels).

Our fair value estimate for MASI is increased to $158 per share (from $145 per share), with bull and bear cases of $170 per share and $146 per share, respectively), reflecting multiples of 22.5x and 9.0x, respectively, to our 2025E forecasts for the core Healthcare and Non-Healthcare segments and incorporates projected net debt (see Exhibit #1 on page 1).

BERY Completes the Spin-Off HH&S Business, which was Merged with Glatfelter (GLT) in an RMT to form Magnera (MAGN); Maintain BUY Ratings on Both Post-Spin BERY and MAGN

Last night, after the market close, Berry Global Group (NYSE: BERY) completed the spin-off of its HH&S business, which was concurrently merged with Glatfelter Corp. (NYSE: GLT) in a Reverse Morris Trust (RMT) transaction to form a new independent, publicly-traded company dubbed Magnera Corp. (NYSE: MAGN), which will begin to trade “regular-way” this morning (as there was no “when-issued” trading period).  

As previously announced, upon completion, BERY shareholders collectively own ~90% of Magnera with GLT investors controlling the remaining ~10%.  To that end, BERY shareholders received 0.276305 shares of MAGN for every BERY share owned (or 31.807098 million shares, accounting for the 13-for-1 reverse stock split effected by GLT on November 4^th).  This implies a post-spin share count at MAGN of 35.34 million (versus our previous assumption of ~34.7 million; see Exhibit 1 on page 2); consequently, we revise our post-spin price target for MAGN to $53 per share (from $54 per share) while our post-spin fair value estimate for BERY remains ~$75 per share (see Exhibit 2 on page 2)

Given initial trading indications we maintain BUY ratings on both post-spin BERY and post-spin MAGN; that said, given the implied upside for each post-spin entity to our estimates we ultimately think the outsized return potential likely lies with MAGN (albeit with a higher degree of initial volatility).

Recall our initial thesis, which we think remains intact, was that the now consummated transaction was set to create two stronger companies with solid fundamentals. Both went through tough cyclical downturns, especially Glatfelter, and carried significant leverage, which weighed on their valuations. This deal helps both companies reduce their debt, return capital, streamline operations, and positions them for growth just as signs of market recovery are starting to emerge.

Keep in mind that Magnera, the smaller entity post-spin, could face some post-spin volatility given its size, which is not likely sufficient for inclusion in the S&P 500 index, but it is seemingly entering the public market with an attractive valuation; to that end, we think shares could offer material upside potential once the initial/natural shareholder rotation is exhausted, which, in our experience, historically persists for ~7-10 trading days following completion (see Exhibits on pages 2-3) .

Also, please see the comprehensive Spin-Off Report dated October 22, 2024 and updates from 10/23/2024, for more information.

MDU Completes the Spin-Off of Everus Construction (ECG); Maintain NEUTRAL Initial Ratings

On October 31, 2024, after the market close, MDU Resources Group Inc. (NYSE: MDU), completed the 100% spin-off of Everus Construction Group (NYSE: ECG).  Shares of ECG were distributed, on a 1- for 4-basis (i.e., one share of ECG for every four shares of MDU), to shareholders of record as of the market close on October 21, 2024.

In so-called “when-issued” (WI) trading), which began on October 28^th, Everus (ECG) opened at ~$49 per share (versus our $51 pe share fair value estimate) while MDU has traded around ~$16 per share (versus our ~$18 per share fair value estimate). Considering Everus will join the S&P Small Cap 600 Index (with a global industry classification standard or GCIS classification as an “Industrial”) and MDU will remain in the same index (albeit reclassified with GCIS classification as a “Utility”) we expect a expect a relatively orderly open (with initial indications suggesting MDU trading at ~$16 per share and ECG poised to open slightly ahead of our fair value estimate). To that end, we maintain an initial stance of NEUTRAL. 

Recall, we downgraded shares of pre-spin MDU (from BUY) on October 17^th following a ~22% rise in the stock following our initial recommendation in June 2024 (compared with a 9.25% increase in the S&P 500 and a 12.85% rise in the Russell 2000).  That said, at the time, we indicated that our longer-term bias was toward the post-spin Everus as it should experience a degree of re-rating toward its engineering & infrastructure construction (E&C) peers over time and has a solid (albeit likely more volatile) growth outlook, in part driven by the expected benefits from, among other things, large government spending programs, such as the Infrastructure Investment & Jobs Act and the Inflation Reduction Act while the post-spin parent, MDU, could be more attractive/suitable for investors seeking stability in earnings and cash flow (with a dividend payout target of 60%-70% and no foreseeable equity issuance prior to 2027) in a now pure-play regulated utility (see Exhibit 3 on page 3).  In that context, we will continue to monitor shares for potential opportunities in initial trading over the coming days. 

Simply for reference (please also see the update published on 10/17/2024 for more information), we note that Everus held an Investor Day on October 17^th during which management re-iterated MDU’s most recent guidance calling for earnings from its regulated energy delivery business (i.e., the post-spin parent) of $170-$180 million along with EBITDA from construction services (i.e. post-spin Everus) of $220-$240 million, which, we note, was maintained despite a modest reduction in its initial sales guidance of $2.9-$3.1 billion to $2.65-$2.85 billion (see Exhibit 1 on page 3) due to its variable cost structure.  That said, in this morning’s discussion, ECG management indicated that including the full-year impact of dis-synergies from standalone public costs, of which the largest is insurance, Everus, on a pro-forma basis, would have generated 2024E EBITDA of ~$202 million (all else being equal).  

Longer-term, with a total available market (TAM) of $365 billion across its transmission & distribution (T&D) and electrical & mechanical (E&M) business, along with its concentration in growing end-markets, such as data centers & AI, (~15% top-line CAGR), grid modernization (~6%), high-tech reshoring (12%) and the overall energy transition (13% sales CAGR), standalone Everus (ECG) projects compound annual organic top-line growth of 5%-7% with an EBITDA CAGR of 7%-9% (see Exhibit 2 on page 3). 

In terms of the pro forma balance sheet, standalone Everus (ECG), per the most recently filed Form 10, had net debt of ~$276.65 million as of June 30^th, including $59.1 million of cash and $335.8 million in debt.  Anecdotally, the company anticipates entering into a 5-year credit agreement with total capacity of $525 million, including $300 million of term loans and a $225 million revolver (on which management expects, given anticipated working capital needs as well as relatively immaterial payments to the parent, will have ~$340 million outstanding upon the spin transaction’s close).  To that end, Everus expects to have an initial post-spin leverage ratio of ~1.3x with a longer-term target level of 1.5x-2.0x (see Exhibit 2 on page 3). 

Capital expenditures are expected to range between 2.0%-2.5% of ECG’s annual sales (see Exhibit 2 on page 3).  Anecdotally, the use of free cash flow (and available debt capacity) will seemingly be focused, at least in the near term, on opportunistic M&A (as opposed to share repurchases and dividends) as a supplement to the company’s organic growth projections. That said, the company did not provide any specific ROIC thresholds for potential future M&A activity but rather simply indicated that any transaction would have to be “the right deal, at the right time, at the right price”.

Please see the Spin-Off Report dated June 10, 2024 and the update from 10/17/2024, for more information.

APG posts roughly in-line 3Q 2024 results; modestly lowers full-year sales & adj. EBITDA guidance while raising FCF conversion to 75%; anecdotal commentary decidedly bullish on 2025E (& longer-term); maintain $42 per share fair value

This morning, before the market open, APG reported 3Q 2024 consolidated sales up 2.4% to $1.82 billion (compared with consensus of $1.87 billion and guidance of $1.86-$1.91 billion) with ~9.5% growth in adj. EBITDA of $245 million (slightly ahead of the consensus estimate of $243.9 million and at the mid-point of guidance); on a high-level, the modest top-line miss and adj. EBITDA beat reflects some project delays in the Specialty and HVAC verticals along with management’s focus on project selection and margins. [Note: Beginning in 2025, APG will realign the reporting of its project-heavy HVAC business into the Specialty Services segment from the Safety Services business.]

By segment, sales at the Safety Services segment rose 9.7% (3.1% organically) with adj. EBITDA growth of ~24.5% to $210 million while Specialty Services posted a top line decline of ~13.5% (7.7% organically) to $493 million with a ~19.5% decline in adj. EBITDA to $67 million.

APG generated $227 million in adj. free cash flow (FCF) in the quarter, implying a conversion rate of ~93%, and ended 3Q 2024 with a leverage ratio of 2.4x (down from 2.7x in 2Q 2024 & within its long-term target of 2.0x-2.5x), reflecting net debt of $2.365 billion (comprised of cash of $487 million & debt of $2.85 billion).

In terms of guidance (see Exhibit #1 on page 2), APG lowered its full-year sales outlook to ~$7 billion (from $7.15-$7.35 billion, although anecdotal commentary pointing to the “lower-end” left consensus at $7.1 billion) with adj. EBITDA of $890-$900 million (versus the prior guide of $885-$915 million & consensus of $894 million), implying growth of 14%-15%. (Anecdotally, the reduction in top-line guidance reflects ~$150 million of timing delays for projects primarily in the Specialty and HVAC verticals.) The company increased its estimate for adj. FCF conversion (as a % of adj. EBITDA) to “at or above 75%” (up from ~70%), suggesting FCF per share of ~$2.40 per share and a yield of ~7%, by our math.

Without providing specific guidance, management indicated “confidence in reaccelerating growth in 2025 and beyond” as well as its ability to achieve (or outperform) its 13% adj. EBITDA margin target (implying adj. EBITDA of $1 billion-plus was in its “sights”). Additionally, APG intends to host an Investor Day in May 2025 at which it expects to “set new meaningfully higher targets for the following 3-years”.

Our base case fair value estimate for Api Group (APG) remains ~$42 per share, reflecting a blended multiple of ~13.5x on F2025E adjusted EBITDA of ~$975 billion along with projected net debt of ~$1.55 billion and a diluted share count of ~284 million (see Exhibit #2 on page 2).

For context, since our initial recommendation in March 2023 APG shares have appreciated ~84.9% (versus a ~38.8% increase in the S&P 500 Index and a ~16.8% rise in the Russell 2000).

That said, with shares trading roughly in-line with our $40 fair value estimate, which reflected a blended multiple of ~12.5x on F2025E adjusted EBITDA of ~$1.01 billion along with projected net debt of ~$1.4 billion and a diluted share count of ~281.5 million (see Exhibit 2 on page 2), we prefer to maintain a disciplined approach and focus our resources on more currently compelling situations; as such, we will close coverage of APG, as of today’s close.

As always, we will continue to monitor the shares for an opportunity to re-recommend if valuation shifts or more tangible steps toward potential strategic alternatives materialize.

PCS Research Services welcomes and encourages your feedback. Please feel free to call us if we can be of service.

LXFR increases full year 2024E adj. EBITDA, EPS and FCF guidance, including the recovery of prior period legal expenses and a property sale; timing for the closing of the closing of the Graphics Arts sale pushed to 1H 2025 (from 2H 2024); fair value remains $16.50 per share

Last night, after the market close, LXFR reported 3Q 2024 consolidated sales up 2.1% to $99.4 million (a marked inflection from the 10.7% top-line declines posted in 1H 2024 albeit largely driven by currency and some customer pull-forwards ahead of hurricane season and potential port strikes) with adj. EBITDA and EPS of $15.4 million and $0.32, respectively. (Excluding legal/insurance recoveries of litigation costs related to the so-called U.S. Ecology case, adj. EBITDA was up ~23% year-over-year to $13.5 million and EPS grew ~35% to $0.27 in 3Q 2024). 

By segment, sales at the Elekton segment increased 7% to $48.8 million with adj. segment EBITDA of $10.8 million while the Gas Cylinders segment posted a top line decline of ~5% to $42.6 million with adjusted segment EBITDA. [The discontinued Graphic Arts segment posted sales of $8 million and was roughly flat from an EBITDA perspective in 3Q 2024.]

Free cash flow (FCF) was $9.3 million in 3Q 2024, and the company ended the September quarter with net debt of $66 million (down from $69.9 million in 2Q 2024), including $3.5 million of cash and debt of $69.5 million.  LXFR’s net leverage ratio at quarter-end was 1.4x (or 1.3x, excluding the Graphic Arts segment), versus ~1.8x at end of 2023 and 2Q 2024. Notably, the company closed the sale of a land property in Lakehurst, NJ late in 3Q 2024 and expects to bank cash proceeds of $7.3 million in 4Q 2024.  The company expects to end 2024 with a leverage ratio of 1.2x (or 1.1x, ex-Graphic Arts).

In terms of financial guidance, management LXFR increased its full year guidance for adj. EBITDA, EPS and FCF to $52-$54 million, $1.09-$1.14 and $35-$37 million, respectively (compared with previous guidance of $47-$50 million, $0.90-$1.00 and $24-$27 million; see Exhibit 1 on page 2).  Excluding the recovery of prior period legal expenses, LXFR’s adj. EBITDA and FCF forecasts would be $45-$47 million, $0.88-$0.94, respectively (versus its previous guide of $42-$45 and $0.75-$0.85). 

In terms of the Graphic Arts sale process, management indicated the timing for the closing of the sale of its Graphic Arts is now expected to be in 1H 2025 (versus previous commentary suggesting 2H 2024). Anecdotally, on this morning’s conference call, management further indicated that the “original buyer” it had identified on last quarter’s earnings call ultimately did not meet the company’s valuations expectations and management is now re-engaged with other interested parties.  [For context, on the 2Q 2024 conference call, LXFR indicated that it was in the last stages of a competitive bid process (that included ~100 prospective buyers) and it had entered exclusive discussions with a single (but unnamed) counterparty.] When pressed on its confidence in the new timing for a transaction management responded that given the level of interest it thought 1H 2025 was a “reasonable” expectation.

Tangentially, the company also reiterated its cognizance that the Gas Cylinders and Elektron businesses have “no material synergies” and that it is committed to continuously evaluating market conditions for opportunities to unlock value (that said, the divestment of the Graphic Arts business is seemingly its top current priority).

Our base case fair value estimate for LXFR remains $16.50 per share, reflecting values of ~$8 per share, ~$10 per share, and ~$0.50 per share for the Gas Cylinders, Elektron and Graphic Arts businesses, respectively. Accounting for projected net debt of ~$2 per share yields a base case sum-of-the-parts fair value of ~$16.50 per share (with bull and bear cases of ~$19 per share and ~$14 per share, respectively; see Exhibit #2 on page 2).

PCS Research Group welcomes and encourages your feedback.  Please feel free to call us if we can be of service.

GLT Shareholders Approve Spin/Merger with BERY; Completion Date Set for Nov. 4^th; Pre- & Post-Spin BERY Values Unchanged, Post-Spin MAGN Moves to $54 Per Share Reflecting a 13-for-1 Reverse Stock Split Ratio (Previously 5-for-1)

This morning, October 23, 2024, Glatfelter Corp.’s (NYSE: GLT) shareholders approved the proposed merger with Berry Global Group’s (NYSE: BERY) Health, Hygiene & Specialties (HH&S) business, whose pending spin-off does not require shareholder approval.

Recall, on February 7, 2024, Berry unveiled its plan to spin off most of its HH&S segment, including its global nonwovens and films business, and merge it with Glatfelter Corporation in a Reverse Morris Trust (RMT) transaction to create a new company named Magnera.

Separately, last night, after the market close, the two companies set the record date for the transaction as the close of business on November 1^st with an expected completion date of November 4^th.

To that end, on November 4, 2024, BERY will: 1) distribute all the stock of its HH&S business (or SpinCo) to BERY shareholders of record; 2) SpinCo will then be merged into a subsidiary of Magnera; and 3) the shares of SpinCo received by BERY stockholders will convert into the right to receive shares in Magnera (NYSE: MAGN).

In terms of trading, shares of Magnera are not expected to begin trading before the start of “regular way” trading at the market open on November 5^th.

For BERY, shares will trade with “due-bills”, including the right to receive shares of MAGN, from November 1st-4^th and “ex-distribution” beginning on November 5^th.

As previously announced, upon completion of the transaction, BERY shareholders will collectively own ~90% of Magnera with GLT investors controlling the remaining 10%.

Notably, the actual/exact share count for post-spin Magnera will still be determined by several factors, including the fully diluted share counts at closing for both BERY and GLT, which, for reference, stood at 115.06 million and 45.95 million, respectively, as of October 20^th (slightly higher than the reported figures of 114.5 million and 45.3 million at quarter-end),  as well as the 13-for-1 stock split that GLT expects to enact just prior to the transaction (i.e., 12:01 a.m. eastern time on Nov 4^th). 

For context on valuation, we were previously assuming a 5-for-1 reverse split at GLT; to that end, while our pre- & post-spin fair value estimates for BERY remain intact (at $90 per share and $75 per share, respectively) our post-spin target for MAGN moves to $54 per share (previously $21 per share, based on 5-for-1 split ratio) to reflect the 13-for-1 ratio that was approved by GLT’s Board this morning (see Exhibits on page 2-3). 

All told, we maintain our pre-spin BUY recommendation on BERY where our $90 per share pre-spin target suggests more than 30% upside for the stock from current levels. 

To that end, we think the pending transaction is set to create two stronger companies with solid fundamentals. Both went through a tough cyclical downturn, especially Glatfelter, and carried significant leverage, which weighed on their valuations. This deal will help both companies reduce their debt, return capital, streamline operations, and position them for growth just as signs of market recovery start to emerge. Magnera, the smaller entity post-spin, will likely face some selling pressure due to its size, which is not likely to be sufficient for inclusion in the S&P 500 index, but it’s likely entering the public market with an attractive valuation, and could offer material upside potential once the initial/natural shareholder rotation is exhausted, which, in our experience, historically persists for ~7-10 trading days following completion (see Exhibits on pages 2-3).

Also, please see the comprehensive Spin-Off Report dated October 22, 2024, for more information.

Downgrade MDU to NEUTRAL (from BUY) Ahead of the Oct. 31^st ECG Distribution Given the Recent Share Price Appreciation and Limited Implied Upside to Fair Value from Current Levels

On September 2, 2024, MDU Resources Group Inc. (NYSE: MDU) announced that its Board of Directors had approved the tax-free spin-off of 100% of its construction services business, which will be called Everus Construction Group (NYSE: ECG), into a standalone, publicly traded company.  Shares of ECG will be distributed, on a 1- for 4-basis (i.e., one share of ECG for every four shares of MDU), to shareholders of record as of the market close on October 21, 2024.

So-called “when-issued” (WI) trading for Everus is expected to begin on (or about) October 28^th under the NYSE ticker ECG WI with “regular-way” trading commencing on November 1st under the ticker ECG.  Following the transaction’s completion, post-spin MDU will continue to trade under the NYSE ticker MDU (with “ex-distribution” trading beginning October 28^th under the NYSE ticker MDU WI).

This morning, Everus held an Investor Day, during which management re-iterated MDU’s most recent guidance calling for earnings from its regulated energy delivery business (i.e., the post-spin parent) of $170-$180 million along with EBITDA from construction services (i.e. post-spin Everus) of $220-$240 million, which, we note, was maintained despite a modest reduction in its initial sales guidance of $2.9-$3.1 billion to $2.65-$2.85 billion (see Exhibit 1 on page 3) due to its variable cost structure.  That said, in this morning’s discussion, ECG management indicated that including the full-year impact of dis-synergies from standalone public costs, of which the largest is insurance, Everus, on a pro-forma basis, would have generated 2024E EBITDA of ~$202 million (all else being equal).

Longer-term, with a total available market (TAM) of $365 billion across its transmission & distribution (T&D) and electrical & mechanical (E&M) business, along with its concentration in growing end-markets, such as data centers & AI, (~15% top-line CAGR), grid modernization (~6%), high-tech reshoring (12%) and the overall energy transition (13% sales CAGR), standalone Everus (ECG) projects compound annual organic top-line growth of 5%-7% with an EBITDA CAGR of 7%-9% (see Exhibit 2 on page 3).

In terms of the pro forma balance sheet, standalone Everus (ECG), per the most recently filed Form 10, had net debt of ~$276.65 million as of June 30^th, including $59.1 million of cash and $335.8 million in debt.  Anecdotally, the company anticipates entering into a 5-year credit agreement with total capacity of $525 million, including $300 million of term loans and a $225 million revolver (on which management expects, given anticipated working capital needs as well as relatively immaterial payments to the parent, will have ~$340 million outstanding upon the spin transaction’s close).  To that end, Everus expects to have an initial post-spin leverage ratio of ~1.3x with a longer-term target level of 1.5x-2.0x (see Exhibit 2 on page 3).

Capital expenditures are expected to range between 2.0%-2.5% of ECG’s annual sales (see Exhibit 2 on page 3).  Anecdotally, the use of free cash flow (and available debt capacity) will seemingly be focused, at least in the near term, on opportunistic M&A (as opposed to share repurchases and dividends) as a supplement to the company’s organic growth projections. That said, the company did not provide any specific ROIC thresholds for potential future M&A activity but rather simply indicated that any transaction would have to be “the right deal, at the right time, at the right price”.

All told, our pre-spin our fair value estimate for MDU Resources Group (MDU) remains $31 per share, consisting of $13 per share for Everus (previously $15 per share), MDU’s pre-spin construction services business, and $18 per share (previously $16 per share) from MDU’s remaining regulated utility/energy delivery business.  On a post-spin basis, accounting for the 1-for-4 distribution ratio, our preliminary post-spin fair value estimate for standalone Everus (ECG) stands at ~$51 per share (see Exhibit 3 on page 3).

Given the limited implied upside to our pre-spin fair value estimate following the stock’s ~22% increase since the publication of our initial comprehensive report in June 2024 (compared with a 9.25% increase in the S&P 500 and a 12.85% rise in the Russell 2000) we downgrade our investment rating to NEUTRAL (from BUY).  That said, depending on initial trading, which could exhibit a degree of initial pressure on ECG considering the natural shareholder rotation (related to sector-, size- and index-related factors), our longer-term bias is likely toward the post-spin Everus as it should experience a degree of re-rating toward its engineering & infrastructure construction (E&C) peers over time and has a solid (albeit likely more volatile) growth outlook, in part driven by the expected benefits from, among other things, large government spending programs, such as the Infrastructure Investment & Jobs Act and the Inflation Reduction Act.  That said, the post-spin parent, MDU, could be more attractive/suitable for investors seeking stability in earnings and cash flow (with a dividend payout target of 60%-70% and no foreseeable equity issuance prior to 2027).

Please see the Spin-Off Report dated June 10, 2024, for more information.

Honeywell International to Spin-Off its Advanced Materials Business

On October 8, 2024, before the market open, Honeywell International Inc. (NYSE: HON) announced plans for a tax-free spin-off of its Advanced Materials business into an independent, publicly traded entity.  The transaction, which does not require shareholder approval, remains subject to customary closing conditions, including the filing & effectiveness of a Form 10 registration statement with the Securities & Exchange Commission (SEC), receipt of various regulatory approvals and the final consent of HON’s Board of Directors, is expected to be completed by “the end of 2025 or early 2026”.

Currently, HON manages its business in four primary operating segments: 1) Aerospace; 2) Building Technologies; 3) Performance Materials & Technologies; and 4) Safety & Productivity Solutions. The Advanced Materials (AM) business, which presently resides as a unit within the Performance Materials & Technologies segment provides sustainability-focused specialty chemicals & materials under such brands as Solstice, Spectra, Hydranal and Aclar, is expected to generate sales of $3.7-$3.9 billion with an EBITDA margin profile greater than 25% in F2024.  As a standalone, management envisions the Advanced Materials company, which has a large-scale domestic manufacturing base, will benefit from more flexible/optimized capital allocation and allow investors to focus their capital more acutely.

In terms of background, this morning’s announcement comes within the context of HON’s overarching corporate strategy of focusing on what management views as three “compelling megatrends”, specifically automation, aviation and the global energy transition.  Toward that end, we note that the company spun-off of its home business, Residio (NYSE: REZI), and its transportation systems (i.e., turbochargers) business, Garrett Motion (NASDAQ: GTX) in 2018.  Anecdotally, while no detailed post-spin financial information has been provided as of yet, management indicated on this morning’s conference call that unlike its prior two spins the intent was not to set free the AM business with a similarly disadvantaged financial profile, both from an income statement (i.e., royalty) or balance sheet (i.e., un-related liability) perspective.  That said, while the company indicated that the spin-off would leave RemainCo with a similar long-term organic growth rate (forecasted to be ~4%-7%) and a similar margin profile but with less cyclicality (seemingly a reference to the historical swings in pricing within the AM business) and capital intensity (to the benefit of its free cash flow profile).  [Tangentially, HON’s chairman & chief executive, Vimal Kapur, indicated that “portfolio management” would be a hallmark of his tenure, suggesting other divestitures may be in the offing over time; to that end we would note that it was reported in the financial press that HON has considered selling its personal protective equipment business seeking a reported price tag of ~$2 billion and as well as the potential of taking its Quantinuum business public at a ~$10 billion valuation.]

In terms of financial guidance, in conjunction with 2Q 2024 results, HON updated its full-year outlook calling for consolidated sales of $39.1-$39.7 billion (up from $38.5-$39.3 billion), implying organic growth of 5%-6% (previously 4%-6%), with segment margin of 23.3%-23.5% (previously 23.8%-24.1%) and adjusted EPS of $10.05-$10.25 (previously $10.15-$10.45), implying growth of 6%-8% (previously 7%-10%).  Operating cash flow is projected to be $6.6-$7.0 billion (versus prior outlook of $6.7-$7.1 billion) with free cash flow of $5.5-$5.9 billion (compared with previous commentary of $5.6-$6.0 billion).  For 3Q 2024 specifically, management projected EPS growth of 3%-7% to $2.45-$2.55 (although on this morning’s conference call management notably indicated that intra-quarter trends were pointing toward earnings coming in toward “upper-half” of its previously articulated range).

In terms of valuation, on this morning’s conference call, management anecdotally indicated its thinking that given its outsized margin profile relative to peers the standalone Advanced Materials (AM) business should trade at a premium to competitors, such as Chemours (NYSE: CC) and Arkema (AKE FP), which trade at ~6x 2025E EBITDA, while a wider group, including ABB Ltd. (ABB SS), Emerson Electric (NYSE: EMR), Rockwell Automation (NYSE: ROK) and Schneider Electric (SU FP), bring the overall group’s average up to ~13.5x 2025E EBITDA.  Applying a 13x multiple to estimated Performance Materials & Technologies segment 2025E EBITDA implies value of ~$36.6 billion. Applying a 16.5x multiple, which is in-line with peers, such as Garmin Ltd. (NYSE: GRMN), L3Harris Technologies (NYSE: LHX), Northrop Grumman (NYSE: NOC), RTX Corp. (NYSE: RTX), Safran SA (SAF FP), and Thales SA (HO FP), to estimated 2025E Aerospace segment EBITDA implies a segment value of $84.8 billion. Next, the Buildings Technologies segment could be compared with Carrier Global (NYSE: CARR), Johnson Controls (NYSE: JCI), Schneider Electric (SU FP) and Siemens AG (SIE GY), which trade at ~15.5x 2025E EV/EBITDA.  Applying the peer multiple to estimated 2025 segment EBITDA implies a value of ~$36.6 billion.  Lastly, applying a 12.5x peer multiple, in-line with peers, such as 3M (NYSE: MMM), Kion Group (KGX GR), MSA Safety (NYSE: MSA), TE Connectivity (NYSE: TEL), Carrier Global (NYSE: CARR) and Zebra Technologies (NASDAQ: ZBRA), to the estimate 2025 segment EBITDA at Safety & Productivity Solutions, implies a segment value of ~$12.9 billion. Accounting for corporate costs as well as projected net debt yields an initial sum-of-the-parts fair value estimate of ~$137.5 billion or ~$210 per share (based on a diluted share count of ~655.5 million).

Jacobs Completes the Spin-Off/Merger of Amentum

• On September 27, 2024, after the market close, Jacobs Solutions Inc. (NYSE: J) completed the spin-off of its Critical Mission Solutions (CMS) & Cyber Intelligence (CI) businesses, which was simultaneously merged with privately held Amentum (AMTM) in a Reverse Morris Trust (RMT) transaction.  Shareholders of record on September 23^rd received one share of AMTM for every one share owned of J. 
• In so-called “when-issued” (WI) trading, Amentum (NYSE: AMTM), which is set to replace Bath & Body Works (NYSE: BBWI) in the S&P 500 Index, initially opened at ~$29.50 and subsequently traded between $27-$28 per share (albeit on an average daily trading volume of ~15K shares) before closing down ~5% on Friday at $25.67 per share (on volume of ~163K shares).  This morning, in initial so-called “regular way” trading AMTM has faced additional pressure with shares trading hands at ~$24-$26 per share (on volume in excess of 3.0M shares so far) compared with our initial post-spin fair value estimate of $33 per share.  For its part, new J is trading roughly flat at ~$130.50 (versus our initial, post-spin fair value estimate of $125 per share).
• Within this context, we have historically observed that, to the extent it occurs, the typical shareholder turnover period persists for around 10-trading days following a spin’s completion (and in this case specifically we note a ~50% shareholder turnover rate would imply ~60 million shares changing hands).  That said, post-spin AMTM’s inclusion in the S&P 500 Index could suggest a milder and more truncated turnover process than historical averages. To that end, we think that with the shares implicitly trading below 9x 2025E EV/EBITDA AMTM may be emerging as the more attractive near-term investment play (despite our positive view on the long-term secular growth prospects at post-spin parent Jacobs, on which we maintain our NEUTRAL rating). All told, against the backdrop of a degree of potential near-term pressure amid an initial rotation of shareholders, which could require as many as 50-60 million shares changing hands in the coming days/weeks (versus less than 4.0 million thus far), we maintain our NEUTRAL rating on shares of AMTM (but note that, all else being equal, we would consider AMTM shares as particularly undervalued relative to peers in the $22-$23 per share range).
• Our Sum-of-the-Parts (SOTP) valuation for pre-spin Jacobs Solutions is based on the derived valuations for both RemainCo (J) and CombineCo (AMTM). This includes the midpoint ownership in CombineCo and the retained equity stake within RemainCo. The Exhibit below shows that the midpoint of the SOTP valuation—14x EV/2025E EBITDA for RemainCo and 11x EV/2025E EBITDA for CombineCo—came out to $143.  For RemainCo, with estimated multiples ranging from 13x to 15x, the price target falls between $116 and ~$135, with a midpoint of ~$125 (14x). For CombineCo, the price target ranges from $28 to $38 using 10x-12x valuation multiples, with a midpoint of $33 (11x). These price targets should be considered when evaluating purchase decisions post-spin.
• Broadly, the separation of Jacobs Solutions into two focused companies mirrors many characteristics of successful past spin-offs.  To that end, the high-growth, higher-margin business will be listed independently and is expected to achieve a higher valuation over time as it establishes itself as a leader in the infrastructure engineering and technical solutions sectors, bolstered by strong secular tailwinds in its markets. Meanwhile, the lower-growth, lower-margin government services business will benefit from increased scale, diversification, and a renewed focus on higher-margin, value-added projects, positioning it to potentially catch up to its better-valued peers. That said, our current sum-of-the-parts (SOTP) valuation for Jacobs Solutions/Amentum does not suggest significant immediate upside, in and of itself. However, with the usual shareholder turnover that could be expected post-spin-off, we think investment opportunities are likely to arise post-spin for both short-term and long-term investors.  Please see the Spin-Off Report dated September 6, 2024, and the update from September 13, 2024, for more information.