The L.S. Starrett Company (NYSE:SCX) is a renowned manufacturer of measuring and cutting equipment. The company’s extensive range includes precision tools, gauge blocks, optical, vision, and laser measurement equipment, saw blades, and precision ground flat stock, all with a focus on precision and quality. SCX serves a diverse customer base in both domestic and international markets. Metalworking, aerospace, medical, oil & gas, government agencies, automobile manufacturers, and skilled craftsmen such as builders, carpenters, plumbers, and electricians are among the industries that use the company’s goods. These industries rely on SCX’s technologies to assure accuracy and reliability in their operations, allowing them to achieve the best results possible. SCX is divided into two segments: North America and International. The North American market accounts for 60% of the company’s overall sales, while the International division accounts for the remaining 40%.

A Financial Snapshot of the Most Recent Quarter

SCX recently disclosed third-quarter FY23 financial figures that were better than the same quarter the previous year. The company’s revenue increased by 2% year on year, reaching an amazing $61.7 million. This increase was driven mostly by a 7% increase in price realization, which offset a 1.2% decline due to currency translation and a 3.8% decrease in volume. Revenue in North America increased by 2.1% year on year, totaling $37 million. This rise can be ascribed to the continued high demand for precision granite products as well as a solid market for SCX’s line of precision measuring tools and saw blades distributed through industrial distribution channels. International revenue increased by 1.8% year on year to $24.6 million. This expansion was driven by a 1.9% rise in pricing realization and a 2.7% increase in volume, which were somewhat offset by a 2.8% negative impact from currency translation.

Although SCX’s gross margin fell 360 basis points year over year, settling at 31.2%, this was mostly due to lower factory utilization as a result of lower production. Given the overall improvement in supply chain circumstances over the previous year, the company strategically changed its attention to working capital reduction and cash generation. The adjusted operating margin fell by 330 basis points year on year to 6.7%. This drop was primarily due to a decreased gross margin. However, it was countered in part by a 30 basis point decrease in selling, general, and administrative (SG&A) expenses as a proportion of sales. SCX earned $7.5 million in net income for the quarter or $0.99 per diluted share. In comparison, net income in the third quarter of the previous year was $4.3 million, or $0.57 per diluted share.

The Topline and Bottom Line Are Not Looking Good

SCX’s revenue dynamics have shifted in recent quarters, with price realization being the key driver of growth while volumes have declined. This tendency is obvious in the 2.4% year-on-year fall in volumes during Q2 FY23, followed by a 3.8% year-on-year decrease in Q3 FY23. Despite having greater backlog levels in 2022, the company saw order intake drop during 2023, resulting in a 13.8% decrease in total backlog during Q3 FY23 compared to the same quarter the prior year. The nine-month period ending in March 2023 had a 9.6% decrease in order intake compared to the same period in 2022. Order intake decreased in both the North America and International divisions, with North America experiencing a 6.8% fall and International experiencing a large 13.4% decrease. The international market, notably in Europe, has been harmed by recessionary pressures as well as the current war in Ukraine, resulting in lower order intake. Although North American order intake has been supported by consistent demand for precision granite products and stable intake through industrial distribution channels for the company’s precision measuring tools and saw blades, year-over-year comparisons have been challenging.

Given these considerations, I anticipate SCX’s revenue growth would be hampered in future quarters. As competitors begin to cut their pricing, the corporation should be forced to lower its prices in order to remain competitive. Furthermore, the continued adverse conditions in Ukraine are projected to have a negative impact on the International segment’s order intake. As a result, I believe the overall forecast for SCX’s top-line growth is negative, with significant roadblocks and uncertainties ahead.

SCX has exhibited a dedication to increasing efficiency in its facilities, which has resulted in increased margins in recent quarters. This emphasis on efficiency has enabled the organization to handle hurdles while remaining profitable. Furthermore, in response to inflationary pressures, SCX enacted price hikes, thus alleviating some of the cost consequences. Despite these efforts, the combination of lower volumes, continuing inflationary pressures, and lower output has offset the positive margin impacts. Volume declines have posed a difficulty, reducing profitability.

Looking ahead, I anticipate margins will improve as inflationary pressures begin to ease. Nonetheless, the continued issue of decreased volumes, along with lower output, could continue to have an impact on margins in the coming quarters.

Valuation

SCX is currently selling at a price-to-earnings multiple of 5.17, based on my forecasts for 2023 EPS of $2.11. This valuation is slightly lower than the 5.3 multiple seen in 2022. Furthermore, when the EV/EBITDA multiple is considered, the values for 2023 and 2022 are 3.6x and 3.8x, respectively. I did a comparison with three similar firms to provide context for the company’s price. Using the EV/EBITDA method, the range for these three companies was 13.10x to 16.6x. When using the P/E technique, the range for these businesses increased from -8.03 to 85.89. Surprisingly, L.S. Starrett emerged as the most reasonably priced alternative in both instances.

Conclusion

Finally, based on an examination of SCX’s financial indicators and valuation multiples, the stock looks to be trading at a favorable level in comparison to both its previous performance and similar companies in the market. The lower P/E and EV/EBITDA multiples indicate that the company’s position is likely undervalued. While SCX has improved in terms of efficiency and revenue, I believe the company’s revenue growth and profitability will be hampered in the next quarters due to lower order intake in North America and globally. I believe there are other potential growth chances in the market and have assigned the stock a Hold rating.

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