Applied Industrial's Recession Is Here

From the looks of the maintenance/repair/overhaul (MRO) and industrial-supply sector, you might think that a recession is all but guaranteed. It's true that reports from Grainger (NYSE: GWW  ) and Fastenal (Nasdaq: FAST  ) haven't exactly helped, but it also seems that quality companies like Applied Industrial Technologies (NYSE: AIT  ) are getting unfairly tarred with the same brush.

Results for AIT's fourth quarter are nothing unexpected from this leading distributor of bearings and various motion-control products. Revenue rose about 11%, and though gross margin slipped a bit, operating income rose by more than 20%. Meanwhile, the company continues to opportunistically purchase its own shares.

While I mean no disrespect toward management, its comment on the conference call about seeing moderating growth in many industries seemed glaringly obvious. Capacity utilization in the manufacturing sector has been close to historical peak levels, and it's hardly unprecedented to suppose that a long string of rate hikes will eventually start to slow down activity.

But there's a difference between "moderating growth" and recession. Genuine Parts (NYSE: GPC  ) is still reporting good numbers, and AIT suppliers like Timken (NYSE: TKR  ) and Parker-Hannifin (NYSE: PH  ) aren't ducking and covering just yet. Sure, growth will slow down, and there may be a dicey quarter here or there. But I think folks have been a little too willing to abandon this space.

I'm going to try something a little new in talking about valuation: I'll use my cash flow model in reverse. I use structural free cash flow as the main input, and I give AIT a discount rate of 11%. Assuming that growth slows down by one-third after five years, and by half again after 10 years, the current price seems to predict mid-to-high single-digit growth for the next 10 years. If you think that AIT can do better, consider adding this stock to your due-diligence list.

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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).


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