Powering Resilience
In today’s industrial landscape, the role of energy storage and power systems is becoming increasingly important. This sector, essential for a range of industrial applications, quietly underpins many aspects of modern infrastructure. From powering critical communication networks to supporting transportation systems, it is a key enabler in our technology-driven world.
At the heart of this industry is the ongoing shift in energy storage technologies. The move from traditional methods to more advanced systems like lithium-ion represents a response to growing demands for efficiency, reliability, and scalability. This change reflects broader global trends, including the push towards renewable energy and the need for more resilient power infrastructure.
Moreover, this industry is poised to benefit from significant global developments. The rise of renewable energy, the electrification of transport, and increasing automation across a vast array of sectors are not just reshaping demand but are also creating new opportunities for growth and innovation.
Before we delve into the story of a key player in this field, let us first set the stage with a short overview of the economy and markets and the Smart Investor calendar.
Economy and Markets: Looking Forward
There are several important reports scheduled to be published in the next few days.
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On Thursday, the National Association of Realtors will release November’s Pending Home Sales report. This report is a leading indicator of future existing home sales. It accurately reflects economic conditions and consumer confidence and is closely watched by investors and policymakers for clues about the health of the economy.
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On Friday, we will receive December’s Chicago Purchasing Managers Index (Chicago PMI) data. This report, published by ISM-Chicago, Inc., captures business conditions across Illinois, Indiana, and Michigan, and is generally accepted as a solid representative of the overall economic conditions. The Chicago PMI serves as a leading indicator, helping policymakers and investors to anticipate changing economic trends in GDP, industrial production, employment, and inflation.
As for the stock calendar, the Q3 2023 earnings season for Smart Investor Portfolio companies has ended, with no earnings reports coming out this week.
The ex-dividend date for Humana (HUM) is December 28th.
Today, we are adding the stock of one of the world’s most prominent industrial battery manufacturers, featuring stellar finances and robust growth prospects.
We are not removing any stock from the Smart Investor portfolio this week. Most of the stocks we now hold are high-conviction buys, and we believe that the portfolio in its current form is well-positioned to continue its strong performance, gaining from the Santa rally and current investor optimism. We will reevaluate the positioning in the New Year, next week.
New Addition: EnerSys (ENS)
EnerSys is a global leader in stored energy solutions for industrial applications. The company manufactures and distributes energy system solutions and motive power batteries, specialty batteries, battery chargers, power equipment, battery accessories, and outdoor equipment enclosure solutions to customers worldwide.
The company was established in 2000 via a management buyout of the industrial battery business from Yuasa Inc., the U.S. subsidiary of the Japanese battery maker GS Yuasa (GYUAF). The buyout was followed by a merger with the Hawker Group, a leading manufacturer of industrial batteries and chargers, in 2002. In the same year, EnerSys acquired Energy Storage Products Group, with the merger and the acquisition shaping Enersys in its current form.
In the years that followed, the company continued to grow and expand its portfolio and global presence both organically and through strategic acquisitions and collaborations. The company has made 36 acquisitions around the globe since its formation. Among its most notable buyouts are two acquisitions made in 2023: Energy Leader Batteries, an Indian manufacturer of industrial batteries, and Industrial Battery and Charger Services, a U.K. provider of battery service and maintenance solutions.
Today, Enersys is the world’s largest industrial battery manufacturer, commanding a market capitalization of $4.3 billion, annual revenues of $3.7 billion, and a global workforce of over 11,000 employees. EnerSys operates more than 32 manufacturing facilities around the world serving over 10,000 customers, from a wide range of industries in 100 countries.
EnerSys’ products and services are focused on three primary markets: Motive Power, Energy Systems, Specialty, and New Ventures. Motive Power applications include original equipment manufacturer (OEM) and aftermarket applications in material handling, railway, and mining markets. This segment is responsible for 39% of the company’s total revenues. Energy Systems applications, a segment that provides 47% of total revenues, include broadband and telecommunications, uninterruptible power supply (UPS), power electronics, security, portable power, switchgear/utility, medical, outdoor enclosures, and sports and leisure. Specialty consists of transportation and aerospace and defense units. Transportation provides vehicle engine starting batteries and accessories for the premium segments of the truck and passenger vehicle markets. This segment is responsible for 14% of the company’s total revenues.
Geographically, ENS derives 73% of its revenue from North America, 21% from Europe and the Middle East, and 6% from Asia. In North America, the company holds a leading market position, while globally it is working to capitalize on high-growth opportunities.
The company is successfully building upon the experience of its predecessor companies, with a combined 125-year history of industrial battery-making. Adding to this rich heritage, ENS invests heavily in innovation, resulting in numerous technological breakthroughs and a rich portfolio of U.S. and international patents. One of the most notable technological contributions made by EnerSys was its role in developing the Thin Plate Pure Lead (TPPL) technology, used today in many applications including data centers, telecommunications, transportation, materials handling, and logistics.
ENS allocates significant resources to research and development (R&D), with over $3.8 million invested in R&D in 2022 alone. This commitment to innovation, supported by a solid business model and strong delivery, has upheld the company’s transformation. Over the last decade, the company shifted its focus from lead-acid batteries to lithium-ion and other higher-power density and lower-maintenance products, allowing it to better answer the storage capacity needs of its clients. Whereas in the fiscal year 2017, the traditional flooded lead-acid batteries were 73% of the company’s sales mix, in the fiscal year 2023 they were only 44%, with the remainder provided by technologically advanced products and services.
EnerSys has a diverse product portfolio tailored to meet the demands of various industries. The company produces PowerSafe, DataSafe, and Cyclon reserve power batteries, crucial for industries like communications, data centers, security, and others, where consistent power is essential. It supplies motive power batteries like Odyssey, Hawker, NexSys, and Ironclad, primarily to customers in the electric vehicle (EV) and industrial machinery industries, where these batteries provide the necessary power to keep operations running. EnerSys also produces batteries for specific applications, such as aerospace and defense, medical applications, logistics and warehousing, among others. EnerSys is a dominant player in several product categories; its PowerSafe and Hawker brands are undisputed market leaders.
EnerSys is uniquely placed to capitalize on the surging need for energy storage solutions, including traditional and renewable energy. The company is a major supplier to the fast-growing solar, wind, and other renewable energy industries. It offers customizable battery-based grid-interactive solar energy systems for homeowners and businesses, as well as off-grid battery-based renewable energy systems and components. Both types of systems are offered under its OutBack Power brand.
The company aims to address the needs of existing and developing end markets, with the total serviceable market size currently estimated at over $30 billion. This market is expected to continue growing at a fast clip, as several megatrends are combining to accelerate demand for energy solutions. These trends include energy transition (electrification and modernization of storage, grid, and distribution); energy security (resiliency of electrical infrastructure and reliability of mission-critical facilities); connectivity (5G, a vision of 6G, and broadband expansion); and automation (different energy needs for automated production and autonomous vehicles).
EnerSys’ financial health is stellar. In the past two years, the company applied significant resources to paying down its debt, reducing its debt-to-equity ratio from almost 100% in early 2022 to 59% today. Its current net debt-to-equity ratio is a medium-low 39%, with the debt well-covered by operating cash flow and interest payments covered by EBIT many times over.
The company’s debt is highly rated by the global credit rating agencies, underscoring the company’s ability to manage its liabilities: it carries a rating of “BB+” at Standard & Poor’s and “Ba2” at Moody’s, representing the third-highest notch within the highest, “investment grade” level of the rating scale.
ENS’s strong liquidity position is underscored by its current ratio of 2.7 and quick ratio of 1.3. The company closed its latest fiscal quarter with $328 million of cash and cash equivalents on the balance sheet, also achieving an adjusted free cash flow (FCF) conversion rate of approximately 120% on a strong free cash flow of $91 million.
As for capital efficiency, EnerSys features industry-beating metrics. While the Return on Equity (ROE) of 15.8% may seem mediocre, it is higher than that of 80% of its industry peers. Meanwhile, ENS’s Return on Assets (ROA) of 6.8% and Return on Invested Capital (ROIC) of 12.2% position the company in the top 25% of its industry.
EnerSys’ profitability metrics are robust and have been improving in recent quarters. Its gross margin of 26.6%, EBITDA margin of 12.9%, operating margin of 9.1%, and net margin of 7.2% are higher than the industry averages, while its FCF margin of 12.2 places it in the top 15% of its industry.
ENS works in a highly cyclical industry, with a large part of its customers also belonging to sectors highly dependent on economic cycles. After several difficult quarters, in which cyclicals were negatively affected by an uncertain economic outlook and harsh monetary conditions, the horizon has begun to brighten. With the U.S. economy slated for a “soft landing” at the worst and the Federal Reserve signaling interest rate cuts in 2024, the cyclical industries are expected to rebound strongly on the back of the improved business sentiment, propping up sales.
On November 8, 2023, ENS reported its financial results for the fiscal Q2 2024 (ended on October 1, 2023). Net revenues rose marginally year-on-year, which was expected on the back of the wide industry slowdown and the company’s post-pandemic surge in sales in the previous year, but still reached a record-high quarterly number. The company saw robust demand for its maintenance-free products within the Motive Power segment, as well as solid demand trends in its Specialty business, which is expected to continue increasing its input in the overall revenue mix as the company rebalances its production lines to put more emphasis on advanced, higher-margin products and solutions. In the quarter, the Energy Systems segment was subtracted from the total top line due to a temporary pause in communication networks customer CapEx spending; the company is using the segment’s weaker period for restructuring this business line.
In FQ2, the company exceeded the analysts’ EPS expectations, with earnings-per-share rising by 66% year-on-year, the fourth consecutive quarter of high double-digit growth. In fact, the company has exceeded EPS expectations for eight quarters in a row, and in 13 out of 16 quarters for which these estimates have been provided.
ENS’s bottom line is substantially helped by tax credits within the Inflation Reduction Act (IRA) of 2022, which, among others, seeks to support battery cell and battery module production on U.S. soil. During the quarter, the company booked an IRA benefit of $22 million; it expects to continue to receive credits concerning its qualifying U.S. production volumes through 2032. Notably, EnerSys results in FQ2 were very strong even before the IRA benefit, with adjusted EPS rising by 19% year-over-year ex-benefits. EPS benefited from favorable price mix actions which outpaced year-on-year cost increases during the quarter.
Based on the strong results of the first two quarters of fiscal 2024, as well as on additional tax credits for which EnerSys’s products are now eligible, the company has lifted its earnings guidance for the fiscal Q3, reflecting a significant increase in expected earnings per share. FQ3 EPS is now expected to come in the range of $2.50 to $2.60, a ~35% increase from the previous management’s estimate for the ongoing quarter.
As for the longer outlook, analysts expect the company’s EPS to increase by a CAGR of 25% over the next two years. EnerSys has a long-term growth strategy in place, which includes achieving an adjusted operating margin of 14%-16% and more than doubling annual EPS by 2027. It also plans to reinvest capital for additional shareholder value creation, while compensating shareholders through dividends and share repurchases.
Notably, EnerSys is a dividend-paying company; its cash payouts have been continuously raised each year since 2013. Although the company’s current dividend yield is a low 0.73%, its stellar cash generation history, a more than modest payout ratio of 11.7%, and an 11-year history of uninterrupted annual payouts suggest that ENS will continue raising its dividends in the years to come. The company’s capital allocation strategy specifically mentions a gradual increase in dividend payouts to a market-competitive level.
In addition to dividends, Enersys rewards its shareholders through opportunistic buybacks. In November 2023, the company’s management authorized a new $100 million stock repurchase program with no expiration date. During FQ2, ENS repurchased $47 million in shares. While the company didn’t perform buybacks in FQ1, it bought $110 million in shares in fiscal years 2020-2023.
EnerSys’ stock performance has been following its industry’s cyclical nature, displaying levels of volatility appropriate for a mid-cap industrial company. The past three years were even more volatile than usual, with the pandemic and reopening strongly impacting the stock, which rose 24% in the period, slightly underperforming its industry as represented by the Industrial Select Sector SPDR Fund (XLI).
ENS reached its all-time high in July 2023, followed by a strong decline on the back of the general market’s weakness and profit-taking. However, exceptional FQ2 results, coupled with a much more favorable economic outlook going forward, helped the stock to rebound strongly, rising by over 23% in less than two months. In the past 12 months, EnerSys’ stock has surged by 41%, outperforming XLI’s 15% increase.
Despite the outperformance, EnerSys trades at attractive valuations. Its TTM P/E of 17.6 and a Forward P/E of 13.6 represent 24% and 40% discounts, respectively, to the Industrials sector’s averages. It also trades below its industry averages, coming in towards the low-mid range as compared to its industry peers.
Analysts are optimistic regarding EnerSys’ stock performance in the near future, based on strong fundamentals and a robust business outlook. TipRanks-scored top Wall Street analysts see an additional upside of 13% for the stock in the next 12 months. However, their price targets may need to be upwardly updated, as they have yet to fully incorporate the company’s guidance update, which was given on December 19th following the regulators’ update leading to the increase in anticipated tax credits.
ENS carries a TipRanks Smart Score rating of 8/10 (“Outperform”) with a “Strong Buy” recommendation:
To conclude, EnerSys displays firm business and financial metrics, as well as a robust growth outlook. We view ENS stock as a winning combination of a short-term bet on cyclical rebound, along with a long-term bet on quality, growth, and compounded income. As such, we view it as a valuable addition to the Smart Investor portfolio.
Charter Members of the 30% Winners Club
*The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
The markets have ebbed and flowed, but the Winners Club ranks remained unchanged, with the biggest movements occurring deep below the 30% threshold.
The Winners Club still includes six stocks: GE, AVGO, ANET, CDW, WCC, and ORCL.
The next in line to enter our exclusive club is still Stellantis (STLA) with a 28.4% gain since purchase. It will be interesting to see whether this robust performer enters the Winners Club, or whether someone else will outrun it to the finish line.
What’s Next?
Our next commentary will come out on Wednesday, January 3rd, before the market opens.
Until then – we wish you a world of investment success!
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Disclaimer
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