Applied Industrial Battles Cost Woes, Growth Prospects Solid

On Jan 2, Zacks Investment Research downgraded Applied Industrial Technologies, Inc. (NYSE:AIT) to a Zacks Rank #3 (Buy) from a Zacks Rank #2 (Buy). Going by the Zacks model, companies holding a Zacks Rank #3 have chances of performing better in line with the broader market in the next one to three months.

Insider Story

Applied Industrial pulled off a positive average earnings surprise of 11.67% in the past four quarters. The company is poised to enhance its profitability on the back of stellar end-market sales, reduced corporate tax rates and greater operational efficacy. Notably, Applied Industrial currently anticipates to report earnings of $4.65-$4.85 per share in fiscal 2019 (ending June 2019), higher than the prior view of $4.48-$4.68 per share. Per our estimates, the company’s year-over-year earnings growth rate is currently pegged at 28.3% and 7.5% for fiscal 2019 and fiscal 2020 (ending June 2020), respectively.

Apart from elevated end-market demand, Applied Industrial believes strategic acquisitions will help improve its top-line performances in the quarters ahead. In this context, the acquisition of Sentinel Fluid Controls (Mar 6, 2017) as well as the FCX Performance buyout (January 2018) are worth mentioning. The Sentinel Fluid Controls buyout has largely supported in strengthening the company’s Fluid Power business. On the other hand, the FCX Performance acquisition has been reinforcing its Specialty Flow Control business. Notably, Applied Industrial expects that FCX Performance will boost its sales by $550 million, and earnings before interest, taxes, depreciation and amortization (EBITDA) by $68 million within 12 months of the deal’s closure.

Applied Industrial anticipates securing revenue growth of 16-18% in fiscal 2019. Per the five-year (2019-2023) objectives, the company intends to generate revenues of more than $4.5 billion via mid-single-digit organic top-line growth. Per our estimates, the company’s year-over-year revenue growth rate is pegged at 17.5% and 3.9% for fiscal 2019 and fiscal 2020 (ending June 2020), respectively.

Nevertheless, amid aforementioned positives, we notice that over the past three months, Applied Industrial's shares have lost 30.4%, wider than the 15.9% decline recorded by the industry it belongs to.

Rising cost, if unchecked, will continue to hurt Applied Industrial's profitability in the quarters ahead. The company expects that increased project work at the process inventory levels and LIFO inventory charge relating to seasonal inventory build might escalate its cost of sales. On the other hand, performance-related incentives paid for improved business performance and annual merit increases might aggravate selling, general and administrative expenses, moving ahead.

Moreover, certain headwinds like consolidation of suppliers' and customers' industries might hurt Applied Industrial's financial performance in the near term. Alliance between suppliers may curtail the company's ability to negotiate favorable pricing and other important commercial terms related to inventory purchases. Consolidation among customers might trigger unfavorable demand trends, thereby increase pricing pressures and hamper its aggregate sales.

Also, on an EV/EBITDA (TTM) basis, Applied Industrial's stock looks overvalued compared to the industry with respective tallies of 10.1x and 9.7x for the past three-month period. This makes us cautious toward the stock.

Stocks to Consider

Some better-ranked stocks in the same space are listed below:

DXP Enterprises, Inc. (NASDAQ:DXPE) sports a Zacks Rank #1 (Strong Buy). The company pulled off a positive average earnings surprise of 112.62% in the past four quarters. You can see the complete list of today’s Zacks #1 Rank stocks here.

Luxfer Holdings PLC (NYSE:LXFR) also flaunts a Zacks Rank of 1. The company generated a positive average earnings surprise of 24.27% in the last four quarters.

Barnes Group, Inc. (NYSE:B) holds a Zacks Rank #2 (Buy). The company delivered a positive average earnings surprise of 7.04% in the trailing four quarters.

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