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Fortive (FTV) was spun off from Danaher (DHR) on July 2, 2016; my recent DHR post is accessible here.
I last reviewed FTV in this October 29, 2022 post at which time Q3 and YTD2022 results had just been released. While I wanted to add to my exposure, I had depleted my liquidity because we purchased a second home.
With the recent release of the Q2 and YTD2023 results, I now revisit FTV.
Business Overview
FTV provides essential technologies for connected workflow solutions. It operates and reports results in three segments:
- Intelligent Operating Solutions;
- Precision Technologies; and
- Advanced Healthcare Solutions
A good explanation of FTV and each of its 3 segments is found in Part 1 Item 1 in the FY2022 Form 10-K.
FTV has adopted the philosophy underpinning the proven Danaher Business System (DBS), which has its roots in the Toyota Production System (kaizen - continuous improvement). By following the highly successful DBS, FTV can generate impressive annual free cash flow conversion much like DHR.
The Fortive Business System involves the acquisition of companies with 'moats', the expansion of operating margins through Lean manufacturing principles, and the redeployment of cash flows into further mergers and acquisitions. FTV targets companies with reputable brand names, large installed bases, and strong cash flows.
Management focuses on recurring revenue and digitalization to reinforce the company's moat by increasing customer switching costs and enhancing its intangible assets. Following the spin-off from DHR, management has focused on boosting recurring revenue in its portfolio. At the time of the spin-off, recurring revenue was ~18%; management's objective was to increase this to ~50% over the next 5 - 7 years.
Financials
Q2 and YTD2023 Results
Links to FTV's Q2 Earnings Release, the accompanying earnings presentation, and the Q2 2023 10-Q are accessible here.
Source: FTV - Q2 2023 Earnings Presentation July 26 2023
Free Cash Flow (FCF)
FTV's FY2017 - FY2022 FCF (in billions of $) is $1.065, $1.275, $1.197, $1.361, $0.911, and $1.207.
Management's definition of FCF is cash provided by operating activities calculated according to GAAP minus payments for additions to property, plant, and equipment.
I look closely at a company's FCF and trend because it provides useful information in assessing a company's ability to:
- generate cash without external financing;
- fund acquisitions and other investments; and
- in the absence of refinancing, repay debt obligations.
Source: FTV - Q2 2023 Earnings Presentation July 26 2023
FCF, however, is not without its drawbacks. As a liquidity measure, it has material limitations because it excludes certain expenditures that are required or to which a company is committed, such as debt service requirements and other non-discretionary expenditures. This is why I look at the credit rating and outlook assigned by major rating agencies (see Credit Ratings section below).
FY2022 Outlook
On the Q2 earnings call, management states that FTV has a ~$0.33B order backlog which it hopes to reduce to ~$0.2B by FYE2023. FTV also expects to continue growing its recurring revenue in the second half of FY2023 as software and consumables sales continue to increase.
Source: FTV - Q2 2023 Earnings Presentation July 26 2023
Long-Term Outlook
Management's FY2023 FCF estimate results in a robust 19% compound annual growth rate in the 2019 - 2023 timeframe.
Source: FTV - Q2 2023 Earnings Presentation July 26 2023
Management expects the compound annual growth rate to slow to 16% over the 2019 - 2028 timeframe. Nevertheless, this is still an impressive growth rate.
Source: FTV - Q2 2023 Earnings Presentation July 26 2023
Credit Ratings
Details of FTV's financing are on page 14 in FTV's Q2 2023 Form 10-Q. Extensive information regarding FTV's financing arrangements is in Note 11 of the FY2022 Form 10-K which commences on page 79 of 135.
FTV's senior unsecured long-term debt credit ratings and outlook are the same as at the time of my prior review.
- Moody's: Baa1 and stable
- S&P: BBB and stable.
Moody's rating is the top tier of the lower medium investment-grade category. S&P's rating is 1 notch lower and is the middle tier of the lower medium investment-grade category.
These ratings define FTV as having an ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to meet financial commitments.
Both ratings are satisfactory for my conservative nature.
Dividend and Dividend Yield
FTV is unlikely to appeal to investors who focus heavily on dividend metrics.
On August 4, 2016, FTV declared its first $0.07 quarterly dividend. Looking at FTV's dividend history, we see no change. This, however, is not unexpected.
FTV was spun off from Danaher (DHR) whose practice is to maintain a low dividend payout ratio; the retention of funds to grow the business is a key priority. This strategy has proven highly successful and I envision no change in FTV's quarterly dividend in the foreseeable future.
At the time of my May 2, 2022 post, FTV shares were trading at $57.50 and the dividend yield was ~0.5%. When I wrote my October 29, 2022 post, shares were trading at ~$64.20 and the dividend yield was ~0.44%.
Shares now trade at ~$77 and the dividend yield is ~0.36%.
The diluted weighted average shares outstanding (in millions) in FY2016 - FY2022 are 347, 353, 351, 340, 359, 352, and 361.
On February 17, 2022, FTV announced that its Board authorized a share repurchase program under which up to 20 million shares can be purchased from time to time on the open market or in privately negotiated transactions. There is no expiration date for the repurchase program, and the timing and amount of repurchases under the program are determined by FTV's management based on market conditions and other factors.
In FY2022, FTV repurchased 7 million shares at an average share price of $63.25. As of December 31, 2022, 13 million shares were remaining for repurchase under the share repurchase program.
In the first half of FY2023, FTV repurchased 2 million shares for ~$129 million (an average price of $64.54) under the share repurchase program. In comparison, FTV repurchased 4 million shares for ~$243 million (an average price of $60.71) in the first half of FY2022; this includes the purchase of 3 million shares at an average share price of $59.71 in Q2 2022.
As of June 30, 2023, 11 million shares were remaining for repurchase under the program.
Valuation
At the time of my May 2, 2022 post, FTV shares were trading at $57.50 and management's revised FY2022 guidance was diluted net EPS of $2.07 - $2.16 from continuing operations and adjusted diluted net EPS from continuing operations of $3.04 - $3.13. Using the current share price and the ~$2.12 mid-point of diluted EPS guidance, the forward diluted PE was ~27. Using the ~$3.09 mid-point of adjusted diluted EPS guidance, the forward adjusted diluted PE was ~18.6.
FTV's valuation based on broker guidance was:
- FY2022 – 22 brokers – mean of $3.10 and low/high of $3.06 – $3.16. Using the mean estimate, the forward adjusted diluted PE is ~18.6.
- FY2023 – 22 brokers – mean of $3.44 and low/high of $3.21 – $3.65. Using the mean estimate, the forward adjusted diluted PE is ~16.7.
- FY2024 – 9 brokers – mean of $3.79 and low/high of $3.46 – $4.25. Using the mean estimate, the forward adjusted diluted PE is ~15.2.
When I wrote my October 29, 2022 post, FTV's share price was ~$64.20 and management's FY2022 GAAP EPS guidance was $2.05 - $2.07 and its adjusted diluted EPS guidance was $3.10 - $3.13. This gave us a forward diluted PE of ~31.2 and a forward adjusted diluted PE of ~20.6.
Using FTV's ~$64.20 price and adjusted diluted EPS broker guidance the following were the adjusted forward diluted PE levels:
- FY2022 – 22 brokers – mean of $3.12 and low/high of $3.07 – $3.15. Using the mean estimate, the forward adjusted diluted PE is ~20.6.
- FY2023 – 22 brokers – mean of $3.35 and low/high of $3.17 – $3.55. Using the mean estimate, the forward adjusted diluted PE is ~19.2.
- FY2024 – 11 brokers – mean of $3.71 and low/high of $3.45 – $4.15. Using the mean estimate, the forward adjusted diluted PE is ~17.3.
Management expected FY2022 FCF/share to be ~105% of adjusted diluted EPS. Using management's adjusted diluted EPS guidance of $3.10 - $3.13 ($3.115 mid-point), FY2022 FCF/share was likely to be ~$3.27 (105% of $3.115). Using this, I arrived at a Price/adjusted FCF ratio of ~19.6 ($64.2/$3.27).
Management's FY2023 diluted EPS and adjusted diluted EPS guidance are currently $2.38 - $2.44 and $3.36 - 3.42, respectively.
With shares now trading at ~$77, the forward diluted PE range is ~31.6 - ~32.4 and the forward adjusted diluted PE range is ~22.5 - ~23.
Using FTV's current ~$77 price and adjusted diluted EPS broker guidance, the following are the adjusted forward diluted PE levels:
- FY2023 – 18 brokers – mean of $3.39 and low/high of $3.34 – $3.42. Using the mean estimate, the forward adjusted diluted PE is ~22.7.
- FY2024 – 18 brokers – mean of $3.71 and low/high of $3.57 – $3.95. Using the mean estimate, the forward adjusted diluted PE is ~20.8.
- FY2025 – 8 brokers – mean of $4.16 and low/high of $3.93 – $4.50. Using the mean estimate, the forward adjusted diluted PE is ~18.5.
Management expects an FY2023 adjusted FCF conversion rate of ~105% of adjusted diluted EPS. Using management's adjusted diluted EPS guidance of $3.36 - $3.42 ($3.39 mid-point), FY2023 FCF/share is likely to be ~$3.56 (105% of $3.39). Using this, the Price/adjusted FCF ratio is ~21.6 ($77/$3.56).
Final Thoughts
I hold 300 FTV shares in one of the 'Side' accounts within the FFJ Portfolio. This position is too small for FTV to be amongst my Top 30 holdings (see my Mid-2023 Investment Holdings Review).
Although I consider FTV to currently be fairly valued, I am refraining from adding to my exposure. I am looking to increase my exposure in companies that are facing short-term headwinds and which appear to have temporarily fallen out of favour. FTV is not such a company.
Rather than add to my FTV exposure at this point, I will patiently wait in the hope of a better valuation at a later date.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long FTV.
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
