More on Leveraged Acquirers
TransDigm (TDG) and McCormick (MKC) may have trouble funding their growth
A few weeks ago, we published All Hail Acquisition Caesar in which we discussed how low return on capital is an Achilles heel for companies that seek to supplement their growth with acquisitions. We looked at Post Holdings (POST) as a company that touts its deal-making abilities as a reason to own the stock. The history of making several deals has given POST a sizeable premium valuation at 30x EPS. Plus, the 2022 inflationary trend for eggs and a few other food-related items has given POST strong top-line growth.
However, we pointed out that POST was already carrying considerable debt of 6x EBITDA. It also didn’t have much cash on hand and the cost of borrowing was going up. How could it pay for another deal? Plus, the return on capital was only about 6% despite tailwinds from inflationary price hikes and slashing marketing costs. We think POST may have a tough time keeping a PE ratio of 30 if it cannot outearn its cost of capital and its near-term results may see higher costs for marketing and interest less the tailwind from inflation.
We believe there are many other companies that fit this mold- companies that have generously rewarded shareholders in the past with dividends and share repurchases as well as being active acquirers of other businesses. All these actions have given these companies premium valuations. The question is can they keep doing what made them popular? Or, will the investing world start to focus more on their true organic growth rate and adjust the valuation multiple down to 15x EPS or 12x EBITDA leading to material underperformance?
Below we will examine TransDigm (TDG) and McCormick (MKC), two other companies which we do not believe can sustain their premium acquisition-driven multiples:
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