Gates Industrial Corporation plc

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Gates Industrial Corporation plc is a global manufacturer of engineered power transmission and fluid power solutions for a wide variety of applications.

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

Gates Industrial Corporation is a global manufacturer specializing in highly engineered power transmission and fluid power solutions. Their products are crucial components in various industries, facilitating the movement of power and fluids within machinery and equipment. The company serves diverse sectors, including:

  • Power Transmission: This segment focuses on providing solutions for transferring power mechanically. This includes belts, tensioners, and related parts used in automotive, industrial, and other applications.
  • Fluid Power: This sector offers solutions for transmitting power using fluids under pressure. Products here encompass hoses, couplings, fittings, and other fluid power components utilized in diverse industries.

Recent Developments

  • In Q3 2023, Gates Industrial Corporation announced that its revenue and earnings were negatively impacted by adverse foreign currency fluctuations, inflation, and supply chain pressures.
  • In Q1 2024, revenues and Adjusted EBITDA declined YoY and QoQ, with the company citing market conditions as a major hurdle, although they plan on managing these challenges and continue focus on cash flow.

Industry Trends and Competitive Landscape

  • Cyclical Demand: Demand for industrial and automotive products is heavily influenced by economic cycles. During economic upturns, capital expenditures rise, leading to stronger demand. Conversely, during recessions or economic downturns, demand can decline significantly as businesses become more cautious about new investments.
  • Increased Competition: The presence of both established players and new entrants in the marketplace intensifies competition and can result in pricing pressures.
  • Technological Advancements: The industry is facing technological advancements, such as electric vehicles (EV) and automation. Although these trends can create new opportunities, they also call for changes in traditional approaches of power transmission and fluid power solutions.

Competitive Advantages (Moat Analysis)

  • Scale and Distribution: Gates boasts a considerable global presence with a large distribution network. This results in an advantage through economies of scale, and the access to and relationships with many global customers.

    Moat Rating: 2/5

    • Strength: The company has a large global distribution network and is well-established in the markets it serves, giving it a slight cost advantage.
    • Weakness: Although the distribution network creates an advantage, the product itself is not so differentiated and is thus vulnerable to price competition. The product is often commoditized with different brands selling the same core product.

  • Intangible Assets: The company has developed expertise and technical knowledge over its long history of operation, along with an ability to manufacture highly engineered products that must perform to high quality standards, which cannot be easily imitated, making them more valuable.

    • Strength: It does involve complicated engineering and knowledge of material science, which are hard to replicate.
    • Weakness: This is good, but this is not sufficient to provide a moat to the business, there is not that big of a moat, to warrant pricing power.

Legitimate Moat Risks

  • Technological Disruption: The company faces a major challenge in the form of new technologies like EVs, which can alter the demand for existing product lines. The company’s ability to adapt and capitalize on these new changes, is a risk that must be accounted for.
  • Competition and Consolidation: The industry has the risk of increased competition and commoditization. This will negatively impact the company’s pricing power.
  • Economic Downturn: Given the company’s cyclical business, their results will see a hit in downturns. Economic downturns can severely reduce cash flow and put the business at risk.

Business Resilience

  • Strong Core Business: The company has a very well-established core business. It can rely on its well-built distribution network and loyal customers to help it stay resilient through any downturns.
  • Focus on Operational Efficiency: Management has emphasized streamlining operations to improve margins, which is a welcome step towards long-term value creation.
  • Diversified Customer Base: Serving a wide variety of end markets gives the company a layer of diversification, reducing reliance on any single industry.

Financial Deep Dive

  • Revenue Trends:
    • In Q3 2023, the company saw sales decline 1.3% YoY.
    • In Q1 2024, revenues came in below expectations, with a $14.5 million, or 1.6%, decline YoY and 4.6% decline QoQ
    • Revenues are expected to see a decline in the coming year, as per the guidance.
  • Profitability:
    • In Q3 2023, EBITDA margin came in at 19.5%.
    • Adjusted EBITDA came in at 14.4% of revenues in Q1 2024 which was significantly lower than expectations, and the adjusted diluted EPS decreased 12% QoQ.
    • They also faced headwinds from higher costs and foreign exchange.
  • Capital Structure:
    • The company had total debt of 2.4 billion as of 2024, and the net debt to adjusted EBITDA ratio was at 2.4x, which is an acceptable level of leverage.
  • Cash Flow:
    • Net cash from operating activities was $186 million in Q1 2024, and free cash flow was $165 million.

Recent Concerns and Management Outlook

  • Management noted the negative impact from market volatility, inflation, and supply chain issues in the latest earnings call.
  • The company did not disclose a full year guidance, but guidance for next quarter is at best flat, thus the coming year will not see much growth.
  • Although profitability remains the focus of the company, they are still facing issues that affect the bottom line in the short term, with rising rates and foreign exchange being a key source of issues.

Understandability Rating: 3 / 5

While Gates Industrial Corporation’s core business of manufacturing engineered components is quite understandable, the specifics of its diverse operations across many industries, and details of global supply chains can be complex to fully grasp. Also the business cycles may not be that easy to understand to a new investor in the industry.

  • Clarity: The general concept of engineered power and fluid solutions is relatively straightforward.
  • Complexity: The breadth of industries served and geographical locations can be difficult to follow. Some of the details and interrelation of the various businesses and segments are complex and can need more effort to fully understand.
  • Transparency: Though they offer detailed financial statements, the complexities of accounting around acquisitions and intangible assets, and global operations make the financial picture less transparent than other companies.

Balance Sheet Health: 3 / 5

Gates’s balance sheet shows a solid footing overall, but their debt position and the presence of intangible assets, brings it down from higher ratings.

  • Liquidity: The current ratio is 1.5, which is healthy, but not very high which implies some liquidity issues during stress situations. The quick ratio is 0.9, which also shows some risk of short term cash.
  • Leverage: A net debt-to-adjusted EBITDA of 2.4 is reasonable, and the company is within its targeted range of 2 to 3 times. Having said that, this ratio is higher than the ideal, and any changes in the macroeconomic conditions might put more pressure on them.
  • Asset Quality: Although the amount of goodwill and intangibles are reasonable, it should be monitored for potential impairments in the future that might bring down profitability.
  • Solvency: There are no major red flags from a solvency perspective, and the business seems healthy.