Franklin Electric Co., Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Franklin Electric designs and manufactures systems and components for moving water and other fluids, mainly for use in the water and fuel markets, with a growing focus on sustainability.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Franklin Electric (FELE) operates through three key segments: Water Systems, Fueling Systems, and Distribution. The company is involved in the design, production and sale of various products such as pumps, motors, electronic controls and monitoring devices, and other related equipment and components used in the movement of water and other fluids.

  • Water Systems: This segment offers a wide variety of pumps, motors, and controls, primarily for groundwater applications but also for various fluid handling tasks including pumping clean water, wastewater, and other industrial liquids. This segment is important because it supports industries that require constant and reliable water movement. It accounts for around two-thirds of FELE revenues.
  • Fueling Systems: This segment manufactures and distributes systems and components used in the transport of fuels including submersible pumps, pipes, and monitoring equipment. This is relevant because it provides necessary components for gas stations, which are essential for people to move around. This segment accounts for around 30% of FELE revenues.
  • Distribution: This segment involves both global distribution of parts as well as providing repair, replacement, and other operating parts. This segment is small but provides much needed additional revenue to make the whole operation work smoothly. This segment is small but important because it provides an easy path for customers to access FELE’s products.

Franklin Electric’s sales are broadly diversified geographically, though with a large portion of revenue coming from North America. Its product line, which is more diversified than most companies in the industry, provides a hedge and a good source for recurring income. From the latest earnings transcript, the company expects to grow its sales, operating profit and EPS over the long term, with expected revenue growth of 8-10% per year, operating profit margins between 17.0-17.5%, and EPS growth between 10-13%. Although these numbers seem high, the current global economy seems to be working in FELE’s favor, making them achievable.

Recent trends in global water management have been positive for the company as populations have become more focused on having good water quality and easy access to clean water, which requires modern pumps, monitoring, and filtering systems. Similarly, global fuel use has not changed much, and it requires a lot of energy to refine and move. The shift toward electric vehicles is increasing the need for charging stations, and this could be another opportunity for FELE going forward.

Moat Analysis

Based on all the information, FELE has an average or slightly above average moat, at a 3 out of 5. Its major moat driver is its brand name and wide product line.

  • Brand: Franklin Electric has a strong brand name that is well-known within the industry. A brand name helps keep market share and customer trust, even though similar product lines exist from competitors.
  • Product line: The company’s diverse product line in both water and fuel systems is very beneficial to the company because it can satisfy a wider array of customers and be a one stop shop for companies that need a lot of different components and systems. This also creates some switching costs, as a change would mean learning a new product line. The company also has a wide and deep product catalog for many different types of pumps and other equipment that makes it harder to copy and compete against.
  • Geographic coverage: The company is located globally, though many sales come from the USA. Having a global footprint allows the company to be exposed to different markets, providing a hedge against a slow down in the USA.
  • Distribution network: FELE has a wide-reaching distribution network, which is hard to replicate. This makes it easier for its products to get to the customer.

Legitimate Risks to the Moat and Business

While FELE possesses certain advantages, it also faces several risks:

  • Commodity Prices: The prices of raw materials such as steel and plastics fluctuate with the market. Due to supply chain instability, it may become hard for FELE to obtain the right materials, and even harder to manage the expenses associated with them. The company has also admitted that rising interest rates may impact future growth.
  • Competition: The industrial pump market, which is a large segment of the business, is extremely competitive. New startups are constantly trying to get some market share. While FELE’s brand name gives it some advantage, it may not always be enough in the face of a very innovative newcomer.
  • Technological changes: The industry is constantly changing with newer types of pumps, electronics, and ways of distributing the products. The company might fail to keep up with the times, and will then lose its edge. For example, they are already noticing a slowdown in some product categories. Similarly, the shift toward EVs may reduce the amount of sales from its fuel business.
  • Global Events: A global economic slow down, or some other black swan event, would lead to a contraction of FELE’s business, as would political factors, trade restrictions, or trade wars. FELE’s international business could also be subject to currency risk.
  • Acquisitions: While the company has done well with acquisitions in the past, it is always possible that it might overpay or integrate badly.
  • Regulations: Increased regulations could mean higher costs and time needed to enter the market. The market could also change with the development of new standards.

Business Resilience

Despite the risks, Franklin Electric displays good resilience due to the following:

  • Product Diversification: As explained above, the company’s products are very diversified in both water and fuel segments.
  • Geographic Diversification: FELE’s presence in multiple regions provides a buffer against economic downturns in specific areas, though most of its revenue is still dependent on the US market, making it still relatively exposed to US related issues.
  • Strong Balance Sheet: As we will see later, FELE is fairly well capitalized with lots of cash on hand. This provides a good cushion against bad times.
  • Management: The company’s management seems dedicated to running the company correctly and seems to be very good at allocating capital.
  • Long-Term Trends: Long term trends such as the need for cleaner water and greater energy efficiency are very positive for FELE.

The company is always looking to grow via acquiring more companies, and it also expects to further expand operations in Mexico and China. Although the demand for pumps and fuel equipment is pretty stable, innovation is still required to capture market share in the long term.

Financial Analysis

Franklin Electric’s financial performance has been quite stable over the past decade, and particularly strong in the last three years, but the most recent quarter is a little weaker.

  • Profitability: FELE has posted strong and consistent profits over the years. Its gross profit margins have historically been around 35%-37%, but have seen an increase in the recent quarters to around 37-38%. This can be attributed to rising prices, though the company admits that it has to deal with “inflationary pressures”. In order to maintain profits with these rising costs, they are focused on product differentiation, value, productivity, and customer intimacy. Operating margins are currently at around 17%, which is quite solid.
  • Revenue Growth: As said earlier, FELE revenue has been consistently growing over the last few years. The company expects to grow at an annual rate of 8-10% going forward, though recent sales have been lower than this. Management has indicated that organic growth will drive results going forward rather than large acquisitions.
  • Cash Flow: The company has good and consistent cash flow. It has a negative cash flow in the investing segment, which isn’t concerning considering that it is investing heavily into growth initiatives. Their finance flows tend to fluctuate, as they will use financing when needed, but they can always pay back what they have borrowed.
  • Balance Sheet: As of the latest report, FELE has almost $200 million in cash and just $275 million in debt. Its debt/equity ratio is therefore quite conservative. It also has a lot of assets. This means it can invest back into its business, make acquisitions, and still stay out of danger.

They have a good liquidity position, with more than enough cash to cover short-term obligations.

Understandability

The business is not very easy to understand and can be classified as a 2/5.

  • Complexity: The company is present in a variety of different markets including water systems, fueling systems, and distribution. Also, there is considerable engineering know how, as they both manufacture systems and also produce components for such systems.
  • Operations: The company sells around the world, and operates in diverse supply chains, which is not always very easy to follow. Also, the various segments and sub-segments of their revenue can be hard to follow.
  • Financial complexity: Its financial reports are not that complicated, but one has to look through and make a few small assumptions to come to a clear conclusion. Also, most of the terms used are standard for a publicly traded company, so there are not many hard to understand jargon.

Balance Sheet Health

FELE has a very healthy balance sheet that is a 4/5.

  • Debt/Equity Ratio: The company has minimal debt, compared to the overall assets and revenue it earns. Its debt-to-equity ratio is very low and does not pose a financial risk to the company.
  • Liquidity: The company has adequate cash on hand, and current assets compared to current liabilities suggest that there will be no problems with liquidity in the short to medium term.
  • Long Term Obligations: The company has limited long term obligations.

Recent Concerns / Problems and Management’s Perspective

  • Lower growth: In the recent quarter, management has noted a decline in revenues. It was also noted that “North American residential pumping remains challenging,” but that the industrial and commercial market “remained solid.” This shows a dependence on the domestic market, and also highlights how cyclical the sales of the company can be.
  • Slowing growth in China: Due to China’s economy slowing down, the company now expects reduced revenue in that region. The company notes, however, that it expects long term results from its expansion and investment in that market.
  • Inflation: The company also says it will focus on maintaining margins in the face of inflationary pressures, which is concerning if they are not able to fully pass on the price increases to the consumers.
  • Supply Chain: Although this isn’t as major of a concern as it used to be in the prior quarters, they are still facing supply chain difficulties.

Management continues to focus on driving long-term organic growth while also integrating acquisitions. They seem optimistic about the long term, and do not seem bothered by the current slow down, suggesting it is a temporary phenomena. However, it is important to closely track whether this turns into a long-term decline.