This Activist Fund Has Doubled Down On Timken

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Per an amended 13D SEC filing last week, Relational Investors has upped its stake of Timken (NYSE: TKR) to 7 million shares, or 7.3% of the company. According to Relational's third quarter 13F filing, the fund owned only 3.2 million Timken shares, making it its 15th largest holding. In a 13D filing during late November, Relational had its stake up to only 5.89 million shares. By doubling its shares owned, and based on market value estimations, Timken could now be one of Relational's top ten holdings.

Timken has two key segments, one being anti-friction bearings and the other steel. Relational has been calling for a spinoff of Timken's steel segment in an effort to unlock shareholder value. Major industrial machinery equipment companies include Regal-Beloit (NYSE: RBC), Illinois Tool Works (NYSE: ITW), Kaydon Corp (NYSE: KDN), and RBC Bearings (NASDAQ: ROLL). It's worth noting that Relational is also pushing for change at top Timken competitor Illinois Tool Works. Relational called Illinois Tool its top stock during the third quarter, with 17% of its portfolio invested in the equipment maker.

The fund jumped into Illinois Tool after seeing breakup value of the industrial giant. The company is looking to unlock value by selling off assets, including the dumping of a majority stake in its laminates segment and the sale of its paint finishing business. This has played a big part in lifting the stock over 20% the last twelve months. It appears Relational sees similar value potential in Timken's stock. Billionaire Jim Simons might also be looking for these value opportunities after upping his stake 93% during the third quarter (check out all the hedge funds owning Timken).

Based on Wall Street analysts’ estimates, the EPS is expected to shape up for 2013 and 2014 as follows:

<table> <tbody> <tr> <td> <p><strong>Timken</strong></p> </td> <td> <p><strong>2012</strong></p> </td> <td> <p><strong>2013E</strong></p> </td> <td> <p><strong>2014E</strong></p> </td> </tr> <tr> <td> <p><em>Earnings Per Share</em></p> </td> <td> <p>$4.47</p> </td> <td> <p>$4.26</p> </td> <td> <p>$4.75</p> </td> </tr> </tbody> </table>

Stacking up the valuation metrics, it appears that Timken is the cheapest on both a price to earnings (next year earnings) and price to sales basis:

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Timken</strong></p> </td> <td> <p><strong>Regal-Beloit</strong></p> </td> <td> <p><strong>Illinois Tool Works</strong></p> </td> <td> <p><strong>Kaydon</strong></p> </td> <td> <p><strong>RBC Bearings</strong></p> </td> </tr> <tr> <td> <p><em>Price to Earnings (next year earnings)</em></p> </td> <td> <p>11.9</p> </td> <td> <p>14.2</p> </td> <td> <p>14.5</p> </td> <td> <p>14.5</p> </td> <td> <p>17.6</p> </td> </tr> <tr> <td> <p><em>Price to Sales</em></p> </td> <td> <p>0.95</p> </td> <td> <p>0.97</p> </td> <td> <p>1.67</p> </td> <td> <p>1.66</p> </td> <td> <p>2.83</p> </td> </tr> </tbody> </table>

The average price to earnings multiple for Timken’s peers comes to 15.2 and a price to sales ratio of 1.78. Based on current 2012 sales estimates of $4.95 billion and peer average price to sales multiple, Timken should be trading 80% higher. Furthermore, an average peer price to earnings multiple on next year's EPS estimates puts Timken as undervalued by 27%. The industrial machinery industry is expected to perform relatively well over the interim, which should help keep valuation multiples elevated.

Beyond the valuation, Timken has one of the best positions relative to profitability and returns:

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Timken</strong></p> </td> <td> <p><strong>Regal-Beloit</strong></p> </td> <td> <p><strong>Illinois Tool Works</strong></p> </td> <td> <p><strong>Kaydon</strong></p> </td> <td> <p><strong>RBC Bearings</strong></p> </td> </tr> <tr> <td> <p><em>Return on Equity</em></p> </td> <td> <p>24%</p> </td> <td> <p>12%</p> </td> <td> <p>19%</p> </td> <td> <p>0.2%</p> </td> <td> <p>15%</p> </td> </tr> <tr> <td> <p><em>Return on Assets</em></p> </td> <td> <p>12%</p> </td> <td> <p>6%</p> </td> <td> <p>10%</p> </td> <td> <p>0.2%</p> </td> <td> <p>13%</p> </td> </tr> </tbody> </table>

 Digging even deeper, Timken has one of the best balance sheets with the lowest debt to equity positions:

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>Timken</strong></p> </td> <td> <p><strong>Regal-Beloit</strong></p> </td> <td> <p><strong>Illinois Tool Works</strong></p> </td> <td> <p><strong>Kaydon</strong></p> </td> <td> <p><strong>RBC Bearings</strong></p> </td> </tr> <tr> <td> <p><em>Debt to Equity</em></p> </td> <td> <p>23%</p> </td> <td> <p>56%</p> </td> <td> <p>46%</p> </td> <td> <p>31%</p> </td> <td> <p>--</p> </td> </tr> </tbody> </table>

Timken’s management sees the two segments as having synergistic positives, but CL King & Associates’ analyst Gary Faber says

The diversification of the company is actually what is causing the discount of stock, which is severe. We think it is up to 50 percent.

Timken also has a cash position of $486 million and debt of only $489 million. Relational has met with Timken management to spur a steel business spin off. The fund’s big investment thesis includes the idea that the two business segments are better off separated. The steel unit is a materials company and the bearings segment is classified as an industrial one. Relational manager Whitworth thinks the company could be worth $55 to $65 per share. A number of insiders were also buying Timken in 2012 (read more about Timken’s insider trading).


mhargra has no position in any stocks mentioned. The Motley Fool recommends Illinois Tool Works. The Motley Fool owns shares of RBC Bearings. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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