Among the few companies in the construction-equipment industry that managed to keep their heads above water this earnings season, Manitowoc (NYSE:MTW) deserves special mention. The maker of cranes not only trampled Street estimates, but its earnings report also revealed some pleasant surprises.
Yet, Manitowoc investors should not get too excited, because the company has several weak areas to work on. If Manitowoc doesn't get its act together, its stock might start losing momentum.
A cut above the rest
Revenue from Manitowoc's crane business climbed 8% year over year during the second quarter. Comparatively, Terex (NYSE:TEX) reported only a 3% rise in second-quarter revenue from its crane division. Caterpillar's (NYSE:CAT) last quarter ended on an even more bitter note, as sales from its construction industries division slipped 9% year over year.
So what is Manitowoc doing right that the others aren't? Well, the recent uptick in construction activity in the U.S. is pushing up sales for Manitowoc cranes, even as rivals battle dwindling demand from international markets. While Manitowoc gets nearly 54% of its total revenue from the North American market, Terex derived only 45% of its crane division sales from the region in the most recent quarter. North America contributed only 37% to Caterpillar's sales in 2012.
While a limited global reach is considered a weakness in today's highly competitive environment, it seems to be working in Manitowoc's favor, for now. Caterpillar was even compelled to lower its full-year guidance because of the glacial pace of growth in key markets like China.
Simply put, as long as the U.S. construction market remains robust, investors can expect Manitowoc's top line to rise. But what I really liked about Manitowoc's last quarter was the improvement in its crane segment operating margin to 9.9% -- a level the company hasn't seen since 2008. While ramping up selling efforts, Manitowoc's management also kept tight control over costs, thereby boosting margins. That's a great sign of management efficiency.
There's a problem here
Unfortunately, things aren't as rosy for Manitowoc's other business, food-service equipment. In the last quarter, the division reported a 5% drop in operating earnings on a flat top line. Yet, investors can take heart: Growth initiatives, like a new facility in Mexico and consolidation of operations in Ohio, have added to Manitowoc's cost in recent months. The company expects these facilities to begin generating revenue by the end of this year.
That said, Manitowoc's management needs to work harder on the food-service equipment business since its growth isn't coming easy. Revenue from the business barely improved one percentage point during the six months from January through June. Although peer Illinois Tool Works' (NYSE:ITW) -- which gets 11% of its sales from the food-service equipment business -- also reported flattish revenue from the division for the first half of the year, it still sports a decent operating margin of 17.7%. Comparatively, Manitowoc posted a 15% operating margin for the business for the six months ended June.
How Mickey D's can hurt Manitowoc...
Things could get even tougher moving forward, since the demand for food-service equipment is related directly to the health of the restaurant industry. Any slowdown in capital spending by restaurant chains will likely hurt Manitowoc's business. For instance, McDonald's (NYSE:MCD), which ranks among Manitowoc's important customers, has trimmed its full-year capital spending forecast by $100 million.
More importantly, McDonald's will now open 50 fewer restaurants this year as it concentrates on renovating its existing restaurants. A new look might increase customer traffic for Mickey D's, but it will hardly make a difference in how much McDonald's buys from Manitowoc. Worse yet, fewer new McDonald's restaurants could mean lower sales for Manitowoc in the future.
...yet help it grow
Nevertheless, you shouldn't underestimate the growth potential in the food-service equipment business. Consumers might be tightfisted now, but the long-term growth story remains intact. Most restaurant companies, including McDonald's, are investing billions of dollars in fast-growing emerging markets, which should open up a window of opportunity for Manitowoc in the years to come. Innovative products, timely launches, and an efficient sales management team could change Manitowoc's fortunes. Whether the company can exploit those advantages has yet to be seen.
While a robust North American construction market can lift Manitowoc's profits, it isn't enough to put the company on a growth trajectory. Until its food-service equipment business picks up, Manitowoc investors might have to deal with disappointment.
More importantly, Manitowoc has a daunting task of unloading its debt, which rose to $1.8 billion as of June 30. With free cash flow that doesn't cover even 10% of its debt, and an interest coverage ratio of just two, I find Manitowoc's balance sheet stretched a little too thin. That cash crunch also leaves the company little room to boost its minuscule dividend yield of 0.4%.
Fool contributor Neha Chamaria has no position in any stocks mentioned. The Motley Fool recommends Illinois Tool Works and McDonald's. The Motley Fool owns shares of McDonald's and Terex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.