Modine Manufacturing Stock: Confirmation of My ‘Hold’ Rating (NYSE:MOD)

In & thesis

I’ve got you covered Modine Manufacturing (NYSE:MOD) stock here on Seeking Alpha since November 2022. Since then, the stock is up an impressive 478%, which is phenomenal compared to any broad market index. However, my optimistic rating moved to “Hold” in mid-April 2024. In my last update (July 2024), we noted significant opportunities Modine had in data centers after strategically acquiring TMGcore and Scott Springfield and improving technology and cooling capacity. On the other hand, we assumed that MOD’s growth went too far: we calculated that even if MOD beats its FY2025 EPS consensus by 10%, the stock’s fair value would be ~$108/share – slightly below the share price at the time.

Despite this conclusion of mine, MOD stock continued to rise further, outperforming the S&P 500.

While the momentum is still there, I think MOD’s potential is likely limited as the stock’s valuation has stretched too far, in my opinion, by almost every measure.

Analysis of Q1 FY2025 results

Modine Manufacturing delivered an excellent performance in the first quarter of fiscal 2025: its net sales increased 6.33% year-over-year to $661.5 million, driven by both organic expansion and acquisitions, partially offset by 24 million USD in divestments and planned 80/20 initiatives. As IR materials say, consolidated organic sales grew 4% year over year, which looks great amid continued margin expansion – gross profit margin increased from 20.6% to 24.6%, an improvement of 400 basis points determined by “80/20 initiatives, favorable sales mix and material cost reductions”. MOD’s EBIT as a percentage of sales increased from 10.7% to 11.2%, while Adjusted EBITDA increased 25% YoY to $100.9 million (with margin improving 240 basis points to 15.3%). So all of this led to adjusted EPS growth of ~22.35% (from $0.85 to $1.04) – much more than Wall Street expected for the quarter:

I like what I see in the performance of the Modine segment in Q1 FY2025.

The Climate Solutions segment had another exceptional quarter, benefiting significantly from the acquisitions of Scott Springfield and Napps. CS’s data center sales were up a remarkable 138% year-over-year, and new data center capacity is expected to come online later in the year. Management says Modine is responding to growing demand for hybrid data center solutions that combine air and liquid cooling products “to optimize cooling efficiency and minimize energy consumption.” Modine is also launching a new cooling distribution unit (CDU) that should integrate with its other data center products, with first deliveries expected in Q4 2025. I sure like the fact that the data centers have now fully compensated for any weaknesses in the heat transfer products sub-segment (sales there were down over 20% y-o-y in Q1) – by diversifying and re-focusing on higher and higher margin- the growth zones do their job; the 80/20 program initiatives seem to be working well.

Looking at the Performance Technologies segment, I see that its sales volumes continue to suffer, primarily caused by “German divestments and lower market demand in the automotive sector.” On the other hand, the segment is experiencing a strategic shift and an evolving product mix, leading to substantial margin improvements: on the back of organic sales falling 1% YoY, adjusted EBITDA margin increased 25% ( +390 bp in margins, YoY ). The company also announced the launch of the Evantage Advanced Cabin Climate System, “designed to provide cabin heating and cooling for commercial, off-highway and specialty electric vehicles.” So, as Modine continues to reduce costs related to legacy businesses and explore opportunities to accelerate exits where possible, I believe that today’s temporary operational weaknesses in certain business areas should not impede overall earnings and flow growth of free cash in the future.

By the way, speaking of Modine’s ability to generate FCF: Last quarter they did $14 million in positive free cash flow, which I think was a promising start to the fiscal year. This cash generation contributed to a $9 million reduction in net debt, bringing the total to $363 million as of June 30. Notably, Modine’s leverage ratio has improved from 1.2x to 1.1x over the past year, which is also a great sign not only for the business’s creditworthiness, but also for the stock’s valuation (lower leverage leads , usually at a higher valuation premium to peers).

On the earnings call, we learned that the Performance Technologies segment may experience a decline in Q2 and Q3 “due to seasonal factors and soft off-highway markets,” but on the other hand, the company raised its full-year guidance year, with Climate Solutions expected to “have relatively consistent revenue for the remainder of the year”:

It’s encouraging to see that management expects 40-50% organic growth in the data center business for the full year, while new manufacturing capacity is “adding in line with market CAGR over the next 3 years.” So based on what I’m seeing, it’s clear to me that the business is growing very actively, which, against the backdrop of the continued 80/20 initiative (still targeting ~$100M revenue streamlining each year), could lead to, if not an acceleration, then at least maintaining high EPS growth rates over the next 2-3 years.

But what about Modine’s rating?

Rating update

Modine’s stock is now trading at one of the most expensive multiples in its public history, while its peers are clearly struggling to maintain their valuation premium. According to Seeking Alpha Premium, Modine currently trades at ~31.6x FY2025 EPS – that’s >2.5x more than Super Micro Computer (SMCI), which trades at just 12.75x next year’s earnings . However, SMCI is more focused on data centers, unlike Modine Manufacturing, so I think the former should command a higher premium.

Modine’s overvaluation is also evident from its EV/EBITDA and EV/Sales multiples, which exceed 17x and 2.5x, respectively, based on next year’s consensus figures – which is quite high on an absolute basis.

But of course there is a logical explanation for this: MOD margins and overall profitability ratios have skyrocketed in recent years, while the leverage ratio (D/E) continues to fall (which, as I wrote above , also causes a rating to appear). premium).

At the same time, in my opinion, the market is already setting most of the future growth, prospects that I write about in the first part of my article today. According to today’s consensus estimates, MOD’s 3-year EPS CAGR should be 14.6%, which looks quite impressive.

I’m not saying these growth rates will be impossible to achieve – I’m just saying they may already be in the stock price. Modine has already hit all-time highs in margins, and while other companies struggle to increase (or at least maintain) their margin levels, MOD’s 80/20 strategy continues to work. But how long the positive effect will last, no one knows. I think the EPS growth rate should start to decline by late 2025 or early 2026 because the company has achieved a consistently high margin and its sales aren’t expanding much; all of which should theoretically lead to multiple shrinkage. But that’s just my guess, of course.

conclusion

I really like the way the company has grown and developed over the last few quarters. Obviously, my mid-April 2024 downgrade was a little premature, as the Q1 FY2025 report made it clear that cost optimization efforts continue amid attempts to establish a foothold in the data center market. However, I don’t like the multiples the stock is trading at today: 17x EV/EBITDA seems too high to me, even considering that EBITDA margins continue to grow. Perhaps the stock’s upside potential isn’t exhausted yet – the momentum factor looks amazing.

However, from a fundamental analysis perspective, I fear that MOD is close to a natural plateau in terms of margins. If so, the current EPS consensus is likely too bullish, which could put pressure on stocks over the medium term. With this in mind, I have decided to reiterate my ‘Hold’ rating today.

Thank you for reading!