Regal Beloit (RBC) - Buy at $31 ?

The Second Quarter Results were released on 4.August.  

Financial Results are consistent with expectations.  

Revenues are down 30%. 

Management has done a fine job of managing A/R, inventory, and A/P in this downturn. They squeezed over $60 million of Cash from working capital in the quarter.  The Current Ratio, excluding cash, more on that later, is a healthy 3.2.  

Gudovac does note that Owner's Book Equity (stripping out Goodwill and other questionable 'assets') is a mere $300 million. This is yet another indication of how weak Regal is at operating metrics - it simply doesn't generate much profit. 

Regal does have a big chunk of cash on its Balance Sheet - $290 million. This is burning a hole in Knuppel's pocket and will likely be used for another acquisition as discussed previously. Owner's should therefore eliminate the cash in pricing Regal. It will be consumed soon enough.  Gudovac can't predict if the forthcoming acquisition will be beneficial to Owners.  However, Regal's past acquisitions have been reasonably priced and have not destroyed much Owner's value.  Owners can expect the pattern to continue. 

So how much should Owner's pay for Regal ? 

Let's start with how much Regal generates...

Annualizing 2nd Quarter EBITDA of $48 million equals $193 million.  

Owners can venture that the 2nd Quarter is more indicative of  the future than TTM results. There is a fair amount of judgement that 2nd quarter results can be annualized.  Gudovac believes that reasonable Owners may differ whether the 2nd quarter results can be sustained. However, Regal's 2nd Quarter results appear to be more-or-less sustainable and can prudently be used to price the Enterprise. 

Free Cash Flow in the 2nd Quarter, less the $60 million of working capital extracted in 2Q,  is $36 million. Annualized  FCF is therefore $144 million. 

Owners can calculate a range of share values applying the Gordon Growth Model to the Free Cash Flow using the Weighted Average Cost of Capital (WACC) .  Gudovac does not believe anyone can calculate a long term WACC  within a few percentage points.  

Corporate Treasury Departments need to develop hard cost-of-capital for medium term allocations. The hard value has more to do with streamlining corporate decision making as well as face saving on the part of Managers. How many CFO's  can tell their Boards "Frankly, our hurdle rate is impossible to calculate with any accuracy" - and still keep their jobs ?  Owners don't need to worry about such pretensions. Owners can accept that WACC isn't Newtonian rather it is Quantum.  

Therefore, Gudovac uses a range of WACC values.  A range of values better expresses the ambiguities of the very long term.   A middling sized century old Enterprise such as Regal with a 50/50 debt to equity ratio might have an 11% WACC.  Gudovac has made a table with a typical range of WACCs  using the 11% as a starting point.  The table indicates a range of values between $39 and $25 per share with a midpoint of $31.88. 

Certain Owners may have a higher appetite for risk than Gudovac and be willing to buy Regal at  $39. Other Owners may be somewhat risk adverse and not buy Regal unless it drops to $25. Gudovac is comfortable at a 11% WACC. Therefore, $31 per share appears to be a reasonable price to pay for RBC. 

Mr. Market appears to have a different risk profile than Gudovac.  Regal has been hovering around $45 per share for a fair number of weeks.  Mr. Market's price implies a WACC of 9 3/8%.  This might be a reasonable WACC for a Fortune 50 Enterprise. Fortune 50 Enterprises raise debt at a few dozen basis points above LIBOR. 

However, Regal needs to pay more than a few dozen basis points on its spread. Regal needs to pay 125 to 200 basis points above LIBOR to raise debt.  This suggests that Mr. Market's WACC of 9 3/8% might be just a trifle optimistic. Owners who buy at the $45 level should expect low returns. 

Finally, please note, the $31 price is modestly  above the $30 price Gudovac established in June. It also is above the price Henry Knueppel sold his shares early this year.  Gudovac believes that Henry Knueppel knows how to value his company. If he sells at $30, Owners should take note. 

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

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