In the summer of last year, I believed that shares of battery maker EnerSys (NYSE:ENS) had recharged. A recovery in sales and margins were welcomed as the company could play a role in the energy transition. Yet, after a run higher in the shares, I believed that valuations looked largely fair.
During the time which followed, EnerSys has fortunately obtained (positive) clarity on the tax situation with regard to credits, which is a big positive sign that will boost earnings for years to come, offsetting some concerns about a lack of operational growth here.
A Quick Look Back
EnerSys has existed in its current form when the company acquired Japanese firm Yusasa back in 2000, and following organic growth and dealmaking efforts, the company now provides battery solutions in motive power, reserve power and aerospace & defense.
No less than 30 M&A deals meant that the business five-folded sales from half a billion in 2000 to $2.5 billion in 2015, with progress being accompanied by 10% operating margins. With these margins resulting in earnings power near $4 per share, a $55 stock in the mid-2010s traded at a modest 14 times earnings multiple.
Ever since then, shares have largely traded in a $50-$100 range, as the pace of progress in these years has been a bit less pronounced, but still decent nonetheless.
For the fiscal year 2023, the company grew sales by 10% to $3.71 billion, yet non-GAAP operating margins of 8.7% actually trail those reported back in 2015. Nonetheless, the company managed to grow adjusted earnings to $5.34 per share. With net debt of $725 million coming in at twice reported EBITDA of $361 million, leverage ratio of 2 times has come down again.
The first quarter for2024 was solid, aided by “one-offs”. Sales were up just a percent to $909 million, yet the Inflation Reduction Act IRC credits made that adjusted earnings rose from $1.15 per share to $1.89 per share. Moreover, the company guided for another $1.82 per share number in the second quarter, with earnings again boosted by these credits.
Pegging earnings power close to $5-6 per share except for these credits, and with net debt down to $681 million, I was turning a bit more upbeat, yet another investment cycle was ahead. The company explored the opportunity to build a new lithium battery gigafactory with capital spending seen around half a billion, roughly 4 times the regular capital spending requirements.
Given all this, I was performing a balancing act in August. While growth was decent, investment requirements were steep, and I was not too impressed with the performance given the rapid growth in the industry at large. I decided to keep a closer eye on the shares from hereon.
Trading Flat
Since the summer, shares of EnerSys have largely traded in an $85-$105 range, with shares now trading at $90 per share.
In November, the company posted flattish second quarter sales at $900 million, with adjusted earnings coming in at $1.84 per share, again aided by IRC credits. The company guided for a similar $1.80-$1.90 per share earnings number for the third quarter, including an estimated IRC 45X tax benefit of $0.50-$0.60 per share, but the IRS had not yet clarified this section, creating uncertainty around this guidance.
In December, some clarity on this topic arrived. The company now believed that (at the midpoint) some $140 million in annual tax credits are granted, up from a previous midpoint around $100 million. This should drive third quarter earnings up to $2.50-$2.60 per share, largely driven by the retroactive aspect of the ruling as well. Moreover, most of these credits are set to last until 2032, providing elevated earnings power for another 8 years to come!
In February, EnerSys posted a 6% fall in third quarter sales to $862 million, attributed to weakness in telecom and broadband clients with volumes down 7%, offset by a 1% increase in pricing. Adjusted earnings came in at $2.56 per share, as communicated. For the final quarter, earnings were seen at a midpoint of $2.03 per share, yet if we factor out an estimated $0.85 per share benefit from IRC 45X benefits, organic earnings performance feels a bit soft at $1.18 per share.
Net debt came down to $578 million, reducing leverage ratios to 1.1 times, with this metric having increased to over half a billion. This is welcomed as the company updated its plans for the gigafactory in February.
This factory is envisioned to be built in Greenville, South Carolina, where the company will develop a lithium-ion cell gigafactory. As part of the $500 million investment, the company has applied or comprehensive incentive packages worth some $200 million. Construction is set to start in 2025, set to be completed in 2027, aiding the transition of the economy and driving further energy independence of the US.
And Now?
The truth is that since the summer we have seen quite some mixed signs. On the one hand, it is very encouraging that tax credits have increased and are set to last for many years, providing welcomed cash flows to the business here. That said, a current $8 per share number relies largely on these credits, with earnings power excluding these credits seen at $4-$5 per share. Moreover, the organic business performance feels a bit soft for quite a few quarters now.
Fortunately, net debt has come down a great deal, to just over 1 times EBITDA, but this has been the result of exploding EBITDA following these tax credits as well, as there now is a clear roadmap with regard to the gigafactory.
However, this will weigh on profitability as well. After all, even if the business gets $200 million in grants and alike, the remaining $300 million capital spending in the plant comes at huge costs, as the company recently issued debt for such a similar nominal amount at a 6.625% coupon. This indicates some $20 million in additional interest expenses, about half a dollar on a pre-tax and per-share basis.
Amidst all this, I remain a bit at odds. While the tax situation and clarification is very welcomed, I am not convinced just yet amidst the weaker operating performance of the business. I continue my wait-and-see approach here, looking for signs of organic growth.