Sun Hydraulics’ Sales Are Set to Soar in 2018, Earnings Not So Much

When Sun Hydraulics Corporation (NASDAQ: SNHY) reported its first-quarter 2018 numbers on May 7, the one thing that stood out in the earnings report was its top-line growth. Strong demand for industrial valves and electronics instrumentation combined with Sun Hydraulics' opportunistic growth moves encouraged the company to upgrade its full-year sales outlook.

However, investors may want to keep an eye on Sun Hydraulics' profits going forward. Here's why.

Sun Hydraulics Q1 results: The raw numbers

The table below gives a snapshot of the key numbers from the company's first quarter, but pay attention to the company's earnings per share (EPS) because it'll matter going forward, as I'll explain later.

Metric Q1 2018 Q1 2017 Year-Over-Year Change
Net sales $97.3 million $81.4 million 19.5%
Net income $11.9 million $10.2 million 16.7%
Diluted GAAP EPS $0.40 $0.38 5.3%
Adjusted EPS $0.46 $0.43 7%

What happened with Sun Hydraulics this quarter

Sun Hydraulics operates two business segments: hydraulics, which primarily caters to industrial markets, and electronics, which manufactures electronic power control, displays, and instrumentation solutions for vehicles and power equipment. The smaller segment, electronics -- which contributed roughly 36% to Sun Hydraulics' Q1 sales -- largely is driving the company's top line, clocking 27.5% growth in the quarter, backed by strong demand from recreational vehicles. The acquisition of Enovation Controls in 2016 clearly is paying off.

That's not to say hydraulics isn't doing well. Sales from the segment grew 15.7% last quarter as demand from all geographic regions remained strong. Key points worth noting for hydraulics are:

  • Order intake is at "record levels."
  • Demand is so strong that supply constraints and production inefficiencies pulled the company's Q1 operating margin down to 21.5% from 25.4% in the year-ago quarter.
  • To offset rising costs, Sun Hydraulics has announced a price hike effective July 1.
  • The company expects supply constraints to ease in the second quarter.

Supply constraints and higher costs pressured Sun Hydraulics' operating income last quarter but were offset by lower interest expense on deleveraging and lower corporate taxes, thanks to the recent federal tax law change. As a result, the company reported a strong 16.7% growth in net profit.

Sun Hydraulics' EPS, however, didn't grow as much because a stock issue in February drove the company's outstanding share count higher by almost 11.4%. The company raised $240 million, part of which was used to pare down debt and fund the acquisition of Faster Group in April.

What management had to say

In a major move last quarter, Sun Hydraulics acquired Faster Group, a manufacturer of hydraulic coupling solutions that serve several markets, including agriculture and construction, for roughly $530 million. CEO Wolfgang Dangel believes the acquisition aligns with the company's Vision 2025 goals, which include hitting $1 billion in sales, with half coming from organic growth and the other half from inorganic growth. Thanks to Faster's addition, Sun Hydraulics bumped up its guidance for fiscal 2018, as Dangel explained:

Looking forward

Here's a look at Sun Hydraulics' updated outlook for the full year:

Metric Previous Guidance ( in Millions) Updated Guidance (in Millions)
Consolidated revenue $370-$385 $490-$505
Hydraulics segment revenue $250-$258 $368-$378
Electronics segment revenue $120-$127 $122-$127
Interest expense $0.1-$0.2 $10.5-$12

I mentioned the interest expense here because it's one of the expenses that are expected to go up as the year progresses. Sun Hydraulics has guided for higher depreciation and amortization costs, as well, which means the company's earnings growth will likely be subdued in 2018 despite strong sales momentum.

That's something to watch out for, as it's important that Sun Hydraulics integrates Faster effectively to unlock greater value for its shareholders without diluting their wealth further. After all, incremental sales should flow through the company's bottom line to eventually benefit investors.

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Neha Chamaria has no position in any of the stocks mentioned. The Motley Fool recommends Sun Hydraulics. The Motley Fool has a disclosure policy.