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Gates (GTES) Rides on Strategic Initiatives, Diverse Portfolio

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Gates Industrial Corporation plc’s (GTES - Free Report) shares have been rallying of late on the back of restructuring and other strategic initiatives as well as diversified product portfolio. Its focus on replacement channel customers and first-fit manufacturers is commendable.

This Zacks Rank #2 (Buy) company’s shares have gained 39.6% in the year-to-date period compared with the Zacks Engineering - R and D Services industry’s 22.7% rally. Its peers KBR, Inc. (KBR - Free Report) , Jacobs Engineering Group Inc. (J - Free Report) and AECOM’s (ACM - Free Report) have also gained 24.1%, 23% and 26%, respectively, in the said period. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The company’s price performance was driven by a solid earnings surprise history, having surpassed the Zacks Consensus Estimate in the trailing six quarters.

Zacks Investment ResearchImage Source: Zacks Investment Research

Let’s delve deeper.

Strategic Initiatives: Gates has been undertaking various restructuring and strategic initiatives to improve productivity across operations. These actions include efforts to consolidate manufacturing and distribution footprint, increase the scale of operations to meet the current demand levels, streamline its back-office functions and relocate certain operations to lower cost locations.

In the fiscal first quarter, the company generated 24.1% year-over-year higher net sales, including 21% core revenue growth. Adjusted EBITDA margin also expanded 530 basis points year over year driven by productivity improvements, volume and strong operational execution.

Resilient Replacement & First-Fit Channels Sales: Gates offers a broad product portfolio to diverse replacement channel customers and original equipment (“first-fit”) manufacturers as specified components. The company’s net sales have been highly correlated with industrial activity and utilization, and not with any single end market, owing to diversification of the business and high exposure to replacement channels. Notably, most of the revenues are generated from replacement channels.

For the fiscal first quarter, sales into replacement channels accounted for approximately 61% of total net sales and first-fit channels contributed nearly 39%. Growth in quarterly revenues was broad based, with the first-fit business registering the most significant year-over-year improvement, led by Diversified Industrial, On-Highway, Off-Highway and Mobility & Recreation end markets. Also, sales into replacement channels witnessed strong year-over-year growth.

Notably, both the company’s segments have been performing well. For the quarter, core sales in Power Transmission and Fluid Power businesses increased 23.1% and 17.5%, respectively. The improvements were concentrated primarily in sales to industrial customers, with industrial first-fit and industrial replacement sales increasing 34.8% and 20.5% year over year, respectively.

Solid Margins: Improvement in gross margin achieved through a combination of volume benefits and productivity initiatives has been aiding its bottom line, and helping to offset COVID-related costs as well as inefficiencies. The company’s fiscal first-quarter adjusted EBITDA margin improvement was driven by increased gross profit, which was the result of higher volumes and improved manufacturing performance. Improved manufacturing performance was primarily driven by higher absorption of fixed costs on improved production volumes.

Solid Prospects: Backed by the above-mentioned factors, Gates has raised its fiscal 2021 guidance. It now expects core revenue growth within 18-21% compared with 9-14% projected earlier. Adjusted EBITDA margin is now likely to expand between 22% and 22.8% (430 bps at the midpoint) compared with 21-22% expected earlier.

Furthermore, the stock still has upside potential left, as is evident from the recent earnings estimate revision trend. Earnings estimates for fiscal 2021 have moved up 12.6% to $1.28 per share over the past 60 days, reflecting 82.7% year-over-year growth. This trend signifies bullish analysts’ sentiments, indicating robust fundamentals and the expectation of outperformance in the near term.

Higher ROE: Gates Industrial’s return on equity (ROE) is indicative of growth potential. The company’s ROE of 7.9% compares favorably with the industry average of 6.3%, implying that it is efficient in using shareholders’ funds.

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