Modine Manufacturing: Fade The Rally Before Buying In

Summary:

• Modine Manufacturing Company has enjoyed a rapid upgrade from a small-cap to medium-cap status within a short span of one year, thanks to the aggressive 80/20 initiative and the resultant profitable growth.
• At the same time, the EV and generative AI boom have driven the demand for zero-emission/ high-density cooling solutions on multiple platforms, triggering long-term growth opportunities.
• This is significantly aided by the divestiture of low growth/ low margin businesses and the acquisition of liquid cooling technologies, tapping into the next-gen Data Center infrastructure trends.
• With Modine Manufacturing also reasonably valued compared to its thermal management/ power peers, we believe that there remains great upside potential ahead.
• Naturally, this is with the caveat that investors wait for a moderate retracement for an improved margin of safety as short interest grows and insider selling intensifies.

MOD’s Profitable Growth Prospects Remain, Thanks To The Promising 80/20 Initiative

Modine Manufacturing Company (NYSE:MOD) is another stock that has enjoyed a rapid upgrade from a small-cap to medium-cap status within a short span of one year.

Most of the tailwinds are attributed to the management’s aggressive 80/20 initiative introduced in June 2022, with the aim of delivering accelerated top-line growth at a normalized 5Y CAGR of +8% and expansion in adj EBITDA margins from 7.7% in 2022 to ~15% in 2027.

This is on top of MOD’s well-diversified offerings across thermal management in commercial vehicles, automotive, and data center markets, along with industrial power generation/ transmission.

This is an important point indeed, since the EV and generative AI boom have driven the demand for zero-emission/ high-density cooling solutions on multiple platforms, one which MOD specializes in.

As a result, it is unsurprising that MOD has reported a bottom-line beat in its FQ4 ’24 earnings call, with revenues of $603.5M (+7.4% QoQ/ -2.3% YoY) and adj EPS of $0.77 (+4% QoQ/ +14.9% YoY) released on May 22, 2024, with FY2024 numbers of $2.4B (+4.8% YoY) and $3.25 (+66.6% YoY), respectively.

Readers must note that the top-line miss is attributed to the management’s strategic divestiture of

“three automotive businesses in Germany that manufactured parts principally for the internal combustion engine in the European market, as well as two coatings aftermarket businesses here in the US,”

with the aim of shedding low growth/ low margin businesses.

This is on top of the decline in sales of Heat Transfer products to $433.4M (-14.2% YoY), attributed to the EU regulatory changes and delays in revenue recognition in FY2024.

Otherwise, MOD has reported a robust growth in the Air-Cooled segment to $674.18M (+4.7% YoY), Liquid-Cooled segment to $505.63M (+4.7% YoY), and Data Center Cooling segment to $288.93M (+57.1% YoY) in the latest fiscal year.

This is attributed to the sustained growth observed in the industrial/ heavy equipment construction/ power generation market, global automotive market, and Data Center market as the generative AI boom also triggers new top-line growth opportunities.

At the same time, MOD bottom-line has improved drastically to gross profit margins of 21.8% (+4.9 points YoY/ +6.7 from FY2022 levels) and adj EBITDA margins of 13% (+3.8 points YoY/ 5.3 from FY2022 levels) in FY2024.

This is proof that the management’s 80/20 initiative is working as intended to drive profitable growth, further aided by the price increases and tight operating expenses.

Despite the recent acquisitions to capitalize on the booming demand for generative AI infrastructures/ liquid cooling technologies, with these efforts consequently triggering an intensified debt leveraging, we believe that MOD’s balance sheet remains relatively healthy.

This is because the company has reported a moderating net-debt-to-EBITDA ratio of 1.18x in FY2024, based on the accelerating adj EBITDA generation growth to $314.3M (+48.1% YoY) and net debt of $371.5M (+30% YoY). This is compared to the leverage ratio of 1.34x reported in FY2023 and 2.82x in FY2020.

At the same time, despite the intensified capex from its manufacturing capacity ramp up, MOD continues to report growing Free Cash Flow of $126.9M (+123.4% YoY) and richer margins of 5.2% (+2.8 points YoY) in FY2024, implying its ability to opportunistically tap into the booming demand for generative AI infrastructures.

This is on top of the prospective return of EV demand from 2026 onwards, once price parity to the ICE platform is achieved and the macroeconomic outlook normalizes with borrowing costs moderating to pre-pandemic averages.

MOD Appears To Be Reasonably Valued, Thanks To The Promising Management Guidance & Robust Market Trends

MOD Valuations

Thanks to MOD’s well diversified opportunities in both EVs/ Data Centers, it is unsurprising that the market has temporarily awarded the stock with relatively premium FWD EV/ EBITDA valuations of 15.32x and FWD P/E valuations of 27.47x.

This is up drastically from its 1Y mean of 11.08x/ 19.06x, 3Y pre-pandemic mean of 6.06x/ 10.42x, and the sector median of 9.73x/ 15.88x, respectively.

MOD’s Peer Comparison

When compared to its other thermal management peers, such as Vertiv (VRT) at 27.83x/ 42.86x, Lennox International, Inc. (LII) at 18.30x/ 24.42x and AAON, Inc. (AAON) at 20.97x/ 33.97x, respectively, it is apparent that the market is highly optimistic about their prospects in general.

The Consensus Forward Estimates

The same optimism has also been observed in the raised consensus forward estimates, with MOD expected to generate a higher top/ bottom-line growth at a CAGR of +8.4%/ +19.2% through FY2027. This is compared to the previous estimates of +5.4%/ +12% and the historical growth at +7%/ +22.6% between FY2017 and FY2024, respectively.

When comparing MOD’s growth projections against VRT at +12%/ +30.3%, LII at +5.8%/ +12.1%, and AAON at +9.5%/ +12.2% through 2026, respectively, it appears that the former’s FWD P/E valuations of 27.47x is reasonable as well.

Much of their near-term tailwinds are attributed to the robust market demand for data center infrastructures in general, as similarly reported by Celestica Inc. (CLS). This is especially since Super Micro Computer, Inc. (SMCI), a leading supplier of complete server solutions, has highlighted the “accelerating need for liquid cooling at new data centers.”

This also explains why MOD has strategically (and rather timely) expanded into liquid cooling technologies from the recent acquisition of Napps Technology in July 2023, TMGcore in January 2024, and Scott Springfield Manufacturing in February 2024.

These tailwinds have also contributed to MOD’s robust FY2025 guidance, with revenue growth of +7.5% YoY, adj EBITDA growth of +19% YoY, and adj EPS of $3.70 (+13.8% YoY), underscoring the management’s confidence of delivering profitable growth ahead.

So, Is MOD Stock A Buy, Sell, or Hold?

MOD 5Y Stock Price

As a result, we can understand why MOD has already charted a new peak, while running away from its 50/ 100/ 200 day moving averages and establishing a robust support level at $81s.

For now, the stock is trading notably higher than our estimated fair value estimates of $89.20, based on the FY2024 adj EPS of $3.25 (+66.6% YoY) and the FWD P/E valuations of 27.47x.

However, we believe that there remains an excellent upside potential of +49.4% to our long-term price target of $151.30, based on the consensus FY2026 adj EPS estimates of $5.51.

MOD’s Growing Short Interest/ Insider Selling

As a result of the attractive risk/ reward ratio and promising long-term generative AI trends, we are initiating a Buy rating for Modine Manufacturing Company stock, though with the caveat that interested investors wait for a moderate retracement nearer to its previous support levels of $81s for an improved margin of safety.

This is because we may see moderate volatility in the near term, as short interest continues to grow to 5.13% at the time of writing (+2.44 points QoQ/ +4.61 YoY). An immense growth in insider selling has also been observed, as the management likely cash in some of their long-term stock options.

Some patience may be prudent here.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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