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Fortive Corporation (FTV) spun off 80.1% of its Industrial Technologies strategic segment to Vontier Corporation (VNT). In January 2021, FTV exited its remaining 19.9% ownership stake in VNT through a tax efficient Debt-for-Equity Exchange, thus completing the final step in the VNT separation.
With the combination of the VNT's spin proceeds, the Debt-for-Equity Exchange and FTV's continued strong free cash flow, FTV reduced its net debt by ~$3B since the beginning of Q4 2020. FTV now has a net leverage ratio of ~ 1.3 times thus giving it significant capacity to pursue key capital allocation priorities.
Summary
- Fortive Corporation (FTV) was spun off from Danaher Corporation (DHR) on July 2, 2016 and adopted Danaher’s philosophy underpinning the proven Danaher Business System.
- Stock filters currently reflect a very low valuation for FTV but this is because filters do not exclude the ~$1.2B Unrealized gain on investment in Vontier Corporation (VNT) as at FTV's December 31, 2020 fiscal year end.
- In January 2021, FTV exited its remaining 19.9% ownership stake in VNT through a tax efficient Debt-for-Equity Exchange with proceeds having been used to repay debt.
- FTV has reduced its net debt by ~$3B since the beginning of Q4 2020 and now has a net leverage ratio of ~ 1.3 times thus giving it significant capacity to pursue key capital allocation priorities.
- I anticipate the bulk of my long-term investment return from FTV will be derived from capital gains versus dividend income.
- Based on FY2021 guidance I would like FTV's share price to retrace to the low $60s before I acquire additional shares.
Introduction
I wrote my only Fortive Corporation (FTV) article on September 4, 2019 at which time I indicated:
- FTV has just announced its intent to split into two companies;
- I initiated a 300 share position within the ‘Side' Accounts of the FFJ Portfolio having acquired shares at @ $66.58/share.
Investors who focus exclusively on 'charting' to make their investment decisions would look at the price I paid versus the current ~$67.20 share price and would think FTV has been a terrible investment. They would completely overlook the fact that in mid-October 2020 I received 120 Vontier Corporation (VNT) which are currently trading @ ~$31.40.
I paid ~$20,000 on September 4, 2019 and now have FTV shares valued @ ~$20,160, VNT shares valued @ ~$3,768 and I have received ~$89 in total dividends from FTV (my FTV investment was not made for the purpose of generating dividend income and VNT currently does not distribute a dividend) for a net increase in value of ~$3857 on a ~$20,000 investment or a ~19.285% return in just under 1.5 years.
I mention this to demonstrate how making investment decisions merely by looking at stock charts does not necessarily reflect the true picture.
I take this opportunity to revisit FTV now that FTV has completed the spin-off of its Industrial Technologies strategic segment to VNT and has just released FY2020 results.
Business Overview
I provided a Business Overview in my September 4, 2019 article. Subsequent to writing that article, FTV has completed the spin-off of its Industrial Technologies strategic segment to VNT. If you go here you will see that two strategic segments are still reflected on FTV's website. Drill down to the Industrial Technologies section, however, and you see no companies are listed. This is because they now fall under VNT (see here).
A description of each of the 18 businesses within FTV's Professional Instrumentation segment can be found here.
FTV has yet to release its 2020 Annual Report but if you looks at the 2019 Annual Report you can find a comprehensive overview of the company commencing on page 12 of 125. Just disregard the overview of the Transportation Technologies and Franchise Distribution descriptions on page 15 of 125 as these are now under VNT.
Q4 and FY2020 Results and FY2021 Guidance
On February 4, 2021, FTV released Q4 and FY2020 results and FY2021 guidance. The accompanying Earnings Presentation can be found here.
On October 9, 2020, FTV completed the separation of its Industrial Technologies segment by distributing 80.1% of the outstanding shares of VNT to Fortive stockholders on a pro rata basis.
On the December 31, 2020 Balance Sheet we see a ~$1.2B Investment in Vontier Corporation representing FTV's remaining 19.9% ownership stake in VNT. On January 19, 2021, through a tax efficient Debt-for-Equity Exchange, FTV completed the final step in the VNT separation.
On the Q4 Earnings Call, management indicated that with the combination of the VNT's spin proceeds, the Debt-for-Equity Exchange and FTV's continued strong free cash flow, FTV reduced its net debt by ~$3B since the beginning of Q4 2020. FTV now has a net leverage ratio of ~ 1.3 times thus giving it significant capacity to pursue key capital allocation priorities.
Looking at the Consolidated Statement of Earnings as at December 31, 2020 we see a ~$1.2B Unrealized gain on investment in VNT which distorts the Net earnings from continuing operations and Net diluted EPS. If we back out this line item, we get $2.09 in Adjusted Diluted Net EPS from Continuing Operations. I will use this figure for comparison purposes in the Valuation section of this article.
FTV generated $0.902B in Free Cash Flow (FCF) from Continuing Operations (Non-GAAP). This figure is derived by taking Operating Cash Flows from Continuing Operations (GAAP) and deducting purchases of property, plant & equipment (capital expenditures) from continuing operations; this is money FTV needs to spend in CAPEX to maintain normal business operations.
FTV is a capital light operation unlike Verizon (VZ) which I analyzed in my previous article.
Credit Ratings
Moody's and S&P Global (SPGI) have assigned a Baa1 and BBB long-term unsecured credit rating, respectively.
Moody's rating is the top tier of the lower medium grade category while SPGI's rating is one notch lower...the middle tier of the lower medium grade category.
Both ratings mean FTV has ADEQUATE capacity to meet its financial commitments with adverse economic conditions or changing circumstances more likely to lead to a weakened capacity of the obligor to meet its financial commitments.
FTV's ratings are investment grade and are satisfactory for my risk tolerance.
FTV instituted a quarterly dividend commencing in 2016 at the $0.07/share/quarter level (see dividend history) and the dividend has remained unchanged since then.
In June 2018, FTV announced the closing of its underwritten public offering of 1,380,000 shares, or $1.38B aggregate liquidation preference, of its 5.00% Mandatory Convertible Preferred Stock (MCPS), Series A, par value $0.01 per share. The shares of MCPS sold in the offering included 180,000 shares (“option shares”), or $0.18B aggregate liquidation preference, issued upon the exercise in full of the underwriters’ over-allotment option
We see on page 103 of 125 that FTV may pay declared dividends in cash or, subject to certain limitations, in shares of FTV common stock, or in any combination of cash and shares of FTV common stock in January, April, July, and October of each year, commencing on October 1, 2018 and ending on July 1, 2021. Dividends that are declared will be payable on the dividend payment dates to holders of record on the immediately preceding March 15, June 15, September 15, and December 15 record date, whether or not such holders convert their shares, or such shares are automatically converted, after the corresponding record date.
On January 26, 2021, FTV declared a quarterly dividend payable on its common shares and MCPS with the quarterly MCPS dividend being $12.50. I expect that on July 1, 2021 the MCPS to be converted to common shares. FTV currently distributes ~$69 million in MCPS dividends on an annual basis and with this coming to an end in a few months we may see a very small increase in the $0.07/quarterly dividend.
The diluted weighted-average shares outstanding (in millions) for 2017 - 2020 was 353, 351, 340, and 359. FTV generates significant free cash flow from which it can repurchase shares but it is also in growth mode so I do not envision a sizable reduction in share count.
The founders (Mitchell Rales and Steven M. Rales) of Danaher Corporation (DHR) are on the Board of Directors at FTV. DHR is not known for having an attractive dividend yield and while share repurchases do occur this is certainly not a priority based on the diluted average number of shares outstanding over the 2011 - 2020 timeframe; funds tend to remain in the company to finance DHR's growth. I envision the same practice will occur at FTV as acquiring/divesting businesses has been the manner in which the Rales have maximized long-term shareholder value in the past.
Valuation
Stock filters reflect FTV's PE as being~14.95 which is based on FTV's $4.49 FY2020 GAAP EPS and the current ~$67.20 share price. Investors need to realize, however, that GAAP EPS includes a ~$1.2B Unrealized gain on FTV's retained investment in VNT common stock.
If we look at the $2.09 in Adjusted Diluted Net EPS from Continuing Operations FTV generated in FY2020 and the current ~$67.20 share price we get an adjusted diluted PE of ~32.2.
Looking at FY2021 guidance we see that management has forecast $2.40 - $2.50 in Adjusted Diluted Net EPS from Continuing Operations and 18 brokers have forecast $2.27 - $2.58 with a mean of $2.50. If we use a $2.45 mid-point of management's guidance and the current share price we get a forward Adjusted Diluted PE of ~27.43.
When I acquired shares at $66.58 and wrote my September 4, 2019 article I arrived at the following valuation:
- 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 is ~18.5 - ~19.3.
The bulk of a long-term investment in FTV will be derived from capital gains as opposed to dividend income. Investors, therefore, must be careful not to grossly overpay when acquiring FTV shares because dividend income is not expected to significantly contribute to a shareholder's long-term investment return.
This is a growth company so I am prepared to acquire additional FTV shares at a higher valuation than I would a company such as Tyson Foods, Inc. (TSN); I covered TSN in this article.
If I were to use a forward adjusted PE of 25 and the $2.45 mid-point of management's FY2021 guidance then a price in the low $60s would seem to be more reasonable.
Final Thoughts
The manner in which FTV creates long-term shareholder value is similar to how Danaher Corporation (DHR) has created shareholder value over the years. I am prepared to pay up a bit for FTV's growth potential but am concerned that current market conditions are overheated and a pullback in FTV's share price should not be ruled out. I do not, therefore, intend to acquire additional shares at the moment.
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, TSN, VNT, and VZ.
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.
