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Fortive Corporation (FTV) announced its intention to separate into two independent, publicly traded companies with the transaction expected to be completed the 2nd half of 2020.
Summary
- Fortive was spun off from Danaher Corporation on July 2, 2016 and adopted Danaher’s philosophy underpinning the proven Danaher Business System.
- Recurring revenue as a percentage of total revenue has increased from ~20% at the time of spin-off to ~35%.
- FTV generates strong Free Cash Flow so as to support its growth-by-acquisition strategy.
- On September 4, 2019 FTV announced its intention to separate into two independent, publicly traded companies with the transaction expected to be completed the 2nd half of 2020.
Introduction
In several articles this year I have expressed my frustration as to the lofty valuation of several companies in which I wish to increase my exposure or to initiate a position. Although I view the vast majority of the companies on my ‘Watch List’ as being too richly priced for my liking, I have made the occasional purchase when I viewed a company’s long-term prospects as attractive and the valuation as fair or attractive; this is my most recent article in which I disclosed a purchase.
On September 4th, I noticed that Fortive Corporation (FTV), a company on my ‘Watch List’, had fallen further out of favor with investors and was the company with the largest pullback in its share price of all the companies I monitor.
Much to my surprise I learned that FTV announced on September 4th its intent to separate into two independent publicly traded companies. I delved further into FTV and its plans to separate the second half of 2020.
Although GAAP EPS guidance for FY2019 has been revised lower the last few quarters I invest for the long-term. Unless there is a permanent impairment to the company’s business I don’t get overly concerned when I see what I deem to be temporary weakness as I view seek to invest in high quality companies that have fallen out of favor with the investment community.
The following is my take on FTV.
Business Overview
FTV was incorporated in 2015 and became a publicly traded company on July 2, 2016 when it formally separated from Danaher Corporation (DHR). Following its spin-off, FTV adopted DHR’s philosophy underpinning the proven Danaher Business System.
The Fortive Business System essentially involves acquiring companies with ‘moats’, expanding operating margins through lean manufacturing principles, and redeploying cash flows into further mergers and acquisitions.
Target companies typically have reputable brand names, large installed bases, and strong cash flows.
FTV’s management has focused particularly on increasing the recurring revenue profile of the portfolio; recurring revenue was ~20% at the time of the spin-off from DHR and is now ~35% and the plan is to increase this to 40%+ over the next few years.
This trend has been driven by acquisitions such as the acquisition of Johnson & Johnson’s advanced sterilization business (~80% recurring revenue), divestitures such as the sale of the automation and specialty unit to Altra Industrial Motion Corp. (AIMC), and an increasing importance of the software-as-a-service business.
FTV seeks to leverage its large installed base and combine connected devices with software to offer customers an integrated package.
I anticipate management will continue to focus on recurring revenue and digitalization to reinforce the company’s moat by increasing customer switching costs.
FTV is a diversified industrial technology growth company encompassing businesses that are recognized leaders in attractive markets. Its well-known brands hold leading positions in advanced instrumentation solutions, transportation technology, sensing, and franchise distribution markets. Its businesses design, develop, service, manufacture and market professional and engineered products, software and services for a variety of end markets, building upon leading brand names, innovative technology and significant market positions.
FTV’s research and development, manufacturing, sales, distribution, service and administrative facilities are located in more than 50 countries across North America, Asia Pacific, Europe and Latin America.
FTV is comprised of two reportable segments, Professional Instrumentation and Industrial Technologies.
Professional Instrumentation
This segment offers essential products, software and services used to create actionable intelligence by measuring and monitoring a wide range of physical parameters in industrial applications, including electrical current, radio frequency signals, distance, pressure, temperature, turbidity, radiation, and hazardous gases.
It consists of the Advanced Instrumentation & Solutions and Sensing Technologies businesses. The Advanced Instrumentation & Solutions business was primarily established through the acquisitions of Qualitrol in the 1980s, Fluke Corporation and Pacific Scientific Company in 1998, Tektronix and Invetech in 2007, Keithley Instruments in 2010, eMaint in 2016, Industrial Scientific and Landauer in 2017, Gordian and Accruent in 2018 and numerous bolt-on acquisitions.
Industrial Technologies
The Industrial Technologies segment offers critical technical equipment, components, software and services for manufacturing, repair and transportation markets worldwide. FTV offers a wide range of products spanning advanced environmental sensors, fueling equipment, field payment, hardware, remote management and workflow software, vehicle tracking and fleet management software, and signaling solutions for traffic light control. The products and services offered serve retail fueling operators, commercial auto-repair businesses, municipal governments and public safety entities and fleet owners/operators, globally.
This segment consists of the Transportation Technologies and Franchise Distribution businesses.
The Transportation Technologies business originated with the acquisition of Veeder-Root in the 1980s and subsequently expanded through additional acquisitions, including the acquisitions of Gilbarco in 2002, Navman Wireless in 2012, Teletrac in 2013, ANGI Energy Systems in 2014, Global Traffic Technologies in 2016, Orpak Systems in 2017 and numerous bolt-on acquisitions.
The Franchise Distribution business was established through the acquisitions of Matco Tools and Hennessy Industries in 1986.
Competition
FTV’s businesses generally operate in highly competitive markets.
FTV is of the opinion none of its competitors offer all of the same product and service lines or serve all of the same markets as it does.
FTV encounters a wide variety of competitors, including well-established regional competitors, competitors who are more specialized in particular markets, as well as larger companies or divisions of larger companies with substantial sales, marketing, research, and financial capabilities.
The number of competitors varies by product and service line. Management has observed increased competition in a number of served markets as a result of the entry of competitors based in low-cost manufacturing locations and increasing consolidation in particular markets. It does, however, believe FTV has a market leadership position in most of the markets served.
Key competitive factors vary among businesses and product and service lines, but include the specific factors such as price, quality, performance, delivery speed, applications expertise, distribution channel access, service and support, technology and innovation, breadth of product, service and software offerings and brand name recognition.
Intention to Separate Announcement
On September 4, 2019, FTV announced its intention to separate into two independent publicly traded legal companies; the transaction is expected to be completed in the 2nd half of 2020.
This presentation provides an overview of the businesses which will remain in the ‘new’ FTV and those which will be part of the ‘Newco’ as well as the rationale for the separation.
When FTV was spun off from DHR, FTV was able to identify and pursue a variety of growth opportunities it was unable to pursue when under the DHR umbrella. Management has indicated the same is expected once FTV splits into two separate legal entities.
Details on the capital structure of the two entities, the respective management teams, etc., have not yet been determined and management indicated on the September 4th conference call with analysts that periodic updates will be provided in the months to come.
Q2 and YTD2019 Results
FTV’s Q2 and YTD2019 results released July 25th can be accessed here and the accompanying Earnings Presentation can be accessed here. (cont’d.)
FY2019 Guidance
On the Q2 earnings call, management provided the following guidance:
- diluted net EPS from continuing operations of $0.55 - $0.60 and adjusted diluted net EPS from continuing operations of $0.83 - $0.88 for Q3.
- diluted net EPS from continuing operations of $2.12 - $2.27 and adjusted diluted net EPS from continuing operations of $3.45 - $3.60 for FY2019.
Credit Ratings
Moody’s has assigned a Baa1 rating on FTV’s senior unsecured long-term debt which is the top tier of the lower medium grade category.
S&P Global has assigned a BBB rating on FTV’s senior unsecured long-term debt which is the middle tier of the lower medium grade category.
Both ratings are investment grade and on the conference call, management indicated it is very important that both entities be investment grade following the separation.
Free Cash Flow (FCF)
Despite FTV’s short history as a separate publicly traded entity, it has adopted its former parent’s proven Danaher Business System thus enabling it to consistently generate strong Free Cash Flow.
The Fortive Business System is rooted in the philosophy of continuous improvement, the elimination of waste, empowering leadership, and engaging with customers.
FTV’s strategy, just like that of DHR, is to acquire companies with economic moats and healthy cash flows, improve the acquired operations through the Fortive Business System, and then the redeployment of cash flows into further acquisitions.
In FY2016, FY2017, and FY2018, FTV generated FCF in excess of $1B/year. In fact, in FY2018, FTV’s FCF conversion ratio was 120%.
In FTV’s President and CEO’s Message to Shareholders in the 2018 Annual Report he stated that:
‘Our strong free cash flow continues to be instrumental in accelerating our growth through investments in innovation and market share expansion, using the powerful commercial tools of FBS. It also fuels our mergers and acquisitions efforts and has kept our balance sheet strong throughout this period of transformation.’
If a company’s dividend / dividend growth / dividend yield are critical factors in your investment decision making process, FTV will hold little appeal as a potential investment.
FTV does not even have a page on its website devoted to its dividend.
FTV introduced a $0.07/quarter dividend in 2016 and the dividend has remained unchanged (see here). In fact, FTV’s most recent quarterly dividend announcement was made August 15th and the quarterly dividend was held constant at $0.07.
With FTV having closed at $66.96 on September 4th, the dividend yield is ~0.4%.
FTV’s focus has been on growth and increasing the dividend and repurchasing shares has not been a priority. As a result, investors should not be alarmed to see that the weighted average common shares outstanding used to calculate diluted EPS in FY2016, FY2017, and FY2018 were 347.3, 352.6, and 350.7 (million shares); This was reduced to 339.8 million for the 6 months ending June 30, 2019.
Valuation
On February 7, 2019, when FY2018 results were released, FTV closed at $74.42 and the following FY2019 guidance was provided:
- FY2019 diluted net EPS from continuing operations of $2.56 - $2.66, giving us a forward diluted PE range of ~27.98 - ~29.07.
- FY2019 adjusted diluted net EPS from continuing operations of $3.40 - $3.50, giving us a forward adjusted diluted PE range of ~21.26 - ~21.89.
On April 25th, when Q1 2019 results were released, FTV closed at $87.79 and the following revised FY2019 guidance was provided:
- FY2019 diluted net EPS from continuing operations of $2.36 - $2.46, giving us a forward diluted PE range of ~35.69 - ~37.2.
- FY2019 adjusted diluted net EPS from continuing operations of $3.55 - $3.65, giving us a forward adjusted diluted PE range of ~24.05 - ~24.73.
On July 25th, when Q2 2019 results were released, FTV closed at $81.80 and the following revised FY2019 guidance was provided:
- FY2019 diluted net EPS from continuing operations of $2.12 - $2.27, giving us a forward diluted PE range of ~36.04 - ~38.58.
- FY2019 adjusted diluted net EPS from continuing operations of $3.45 - $3.60, giving us a forward adjusted diluted PE range of ~22.72 - ~23.71.
Fast forward to September 4th when I acquired shares at $66.58.
- Using FY2019 diluted net EPS from continuing operations of $2.12 - $2.27, the forward diluted PE range is now ~29.33 - ~31.41.
- Using FY2019 adjusted diluted net EPS from continuing operations of $3.45 - $3.60, the forward adjusted diluted PE range of ~18.5 - ~19.3.
Although the valuation using GAAP earnings is somewhat rich, I am prepared to ‘pay up’ for a company in which I envision a promising future.
Final Thoughts
The negative trend in projected diluted net EPS from continuing operations is certainly not encouraging. I, however, approach investing with the long-term in mind.
I am fully aware that the business environment has become more challenging over the past few quarters and while it is not unreasonable to assume that business conditions could deteriorate by the time FTV splits into 2 companies in 2020, I envision FTV and ‘Newco’ will be far more profitable several years into the future.
I recognize there are many unanswered questions regarding the split but am confident that management with its DHR background will do what is right to position FTV and ‘Newco’ for long-term success.
Based on my analysis and long-term outlook, I initiated a position within the ‘Side Accounts’ of the FFJ Portfolio by acquiring 300 FTV shares @ $66.58.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long FTV.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
