Vontier: An Underrated Compounder Trading At A Significant Discount
Vontier Corporation (NYSE: VNT $25.17) MV = $4.1bln; EV = $6.3bln; 3mo ADV = 1.98mm shares
Trades @ 8.5x 2023E EBITDA; 9x 2023E FCF; Net Leverage Ratio = 3x
Blended Price Target: $36 or 44% Upside
Disclaimer: I own common shares in VNT. Please do your own work.
LINK TO 1-PAGER HERE
A spinoff of a Danaher spinoff, Vontier Corporation (ticker: VNT) is a misunderstood compounder that trades at a significant discount to peers despite its top-tier pedigree, growth prospects and capital allocation optionality. Today’s VNT has a compelling financial profile – consistent topline growth with steadily increasing margins thanks to Vontier Business Systems (VBS), generating a low teens FCF yield with minimal capex requirements. Applying a sum-of-the-parts (SOTP) analysis, VNT is conservatively worth 44% more than where it trades today, and on a FCF yield basis, should be a double. We get this opportunity given a quirky 2023 guide down that a): is conservative, b): doesn’t reflect changes to the secular drivers of growth and c): can be addressed through capital deployment. Fortunately, management has recognized the value here, recently instituting a $250mm ASR with both the CEO and CFO buying stock personally. Ultimately, we view this change in capital allocation, continued diversification away from internal combustion engine (ICE) exposure via M&A, steady execution and portfolio pruning as catalysts for a re-rating. While you wait, VNT will be minting money, generating over $3/share of FCF, which compares favorably to today’s $25 share price.
‘Vontier is a high-quality, low cyclicality, industrial technology company serving a large and attractive market. VBS is the foundation of what we do, and it enhances our organic growth profile and further expands industry-leading margins. Our capital deployment will be focused on strategic and financially disciplined M&A, and we have an excellent runway of improvements ahead. We have the expertise and leadership to execute a transformational compounding strategy to unlock shareholder value. And we think we have a great business with lots of runway for improvement.’ – CEO Mark Morelli 2020 Baird Global Conference
Today’s VNT is a collection of businesses largely acquired and grown under Danaher’s ownership and maintain Danaher’s DNA of steady growth and strong margins with a focus on R&D and FCF generation. VNT reports two segments: Mobility Technology or MT (76% of revenue) and Diagnostic & Repair Technology or DIRT (24% of revenue). Over time, these businesses have had a successful track record of organic and inorganic growth which along with operating best practices (VBS), has resulted in a higher margin portfolio. Overall revenue CAGR from ’05-’20 was ~5.5% with organic growth making up ~4%, better than its industrial peers. VNT has low cyclicality with revenue down only 6% in ’08 and 1% in ’20. In addition, the combination of businesses has a strong margin profile (gross margins mid-40s, EBITDA margins mid-20s) relative to peers with excellent FCF conversion (>100% of Net Income) and a focus on R&D (4% of revenue) over Capex (2% of revenue). Finally, the continued implementation of VBS has generated significant margin expansion and, going forward, is expected to generate 25 – 50bps of margin improvement a year.
VNT’s MT segment is 90% comprised of its Gilbarco Veeder-Root (GVR) business, the world’s #1 provider of technology for fueling infrastructure, whose products include fuel dispensers, point of sale systems, tank monitoring systems, and EV chargers. Thanks to solid organic growth, shrewd M&A and VBS, GVR sales and operating margins have risen from $400mm and single digits in 2002 to $2bln and mid-20% in 2021. Drivers of the business include growth of the car parc (vehicles on the road) and increasing regulatory standards for both the enviroment and payments. Another key driver of growth is the increasing offerings of C-Stores, such as food and self-checkout, and continued consolidation from the largest operators (GVR works with 17 of the 20 largest operators) who can invest in better infrastructure. In the C-Store, VNT is the #1 provider of payment solutions globally, the #2 provider of point of sales software in North America and the #1 provider of site automation solutions in high growth markets (HGMs). These products and services are powertrain agnostic, high on the C-Store value chain, and provide a growing base of recurring software and maintenance revenue.
GVR Products and Offerings
Source: Company Presentation
We believe that VNT’s broader GVR business gets painted as a proxy for ICE exposure in developed markets. In our view, while the fuel dispensing and related point of sales equipment does make up ~45% of GVR’s revenue or ~30% of overall revenue, their install base gives VNT a strong foothold in several compelling adjacencies and geographies. First, the fuel dispensing business enables VNT to embed itself within the C-Store, which have 80% share of US fuel sales and whose US in-store sales have grown consistently (5% CAGR from ’99 to ’20). Second, the fuel dispensing business gives VNT a right to play in high growth and high margin enviromental protection which has secular tailwinds from increasingly stringent regulation globally. Finally, VNT’s fuel dispensing business gives it a right to win in HGMs, where the number of gas stations per population is an order of magnitude lower than in the US and the number of ICE vehicles are expected to grow over the next decade, generating strong demand for refueling equipment. HGMs which comprise 25% of GVR’s revenues or 15% of overall revenue, also have meaningful upside from more sophisticated C-Store build outs; currently HGM’s content per location is $30-40K versus $75-100K in the US. While we don’t see either gap fully bridging, we do see this as another strong growth driver.
Drivers Of Growth In HGMs
Source: Company Presentation
The recent acquisition of DRB, a market leading integrated provider of POS, workflow software and control systems to the car wash industry, marked a critical step in improving VNT’s financial profile and diversifying away from ICE exposure. DRB has close to a 100% retention rate with accretive margins and 40% recurring revenue, well above the company average in the mid-20s. Critically, the car wash industry is growing mid-single digits while DRB is currently growing in the high teens, meaningfully contributing to MT’s overall growth. The DRB deal represents the first transformative deal that has occurred within MT since its Danaher days. Prior to the spin and under Fortive (ticker: FTV) ownership, less than 5% of FTV’s capital was deployed for VNT-related M&A. Looking forward, management has been clear that future M&A will be focused on similar GVR adjacencies, that are growth and margin accretive, tech-enabled, asset light and FCF generative.
DRB Products and Offerings
Source: Company Presentation
VNT’s other reported segment, Diagnostic and Repair Technologies or DIRT are auto after-market businesses that are powertrain agnostic and tied to the car parc, miles driven, and increasing vehicle complexity. Matco Tools, estimated to be 80% of DIRT’s revenue, provides tools and diagnostic hardware/software for complex vehicle repairs. Its growth is linked to its franchise base which has grown at a ~2.5% CAGR over the last decade. This business is the highlight of the DIRT portfolio, with gross and operating margins estimated in the 50s and 30s respectively. DIRT’s second piece, Hennessy Industries is a leading manufacturer of aftermarket wheel-service equipment, which is tied to tire replacements. It has a self-help story margin story, with margins currently in the high single digits and expected to expand into the teens. Given the lack of ICE exposure, the growth story here is a little simpler (LSD) and with a direct comp in Snap-On (ticker: SNA), valuation is more straightforward.
Why Are We Getting This Opportunity?
‘ . . . We've always said it's $400 million to $500 million, what's new is that we're defining the size and the shape of the tail. We're not changing the overall guidance we've given prior on the magnitude. It's just -- that's the largest year-over-year decline is going to be 2023, and then we move on from there because it's done.’ -- CEO Mark Morelli Q4 2021 Earnings Call
The key reason VNT traded down from its September 2021 peak of ~$37 was the messaging around the ‘tail’ of EMV revenue. Briefly, EMV (Europay Mastercard Visa) is a global security standard that requires a chip reader inside of a credit card POS device to reduce fraud. US regulations required that gas station operators install EMV-compliant systems for their outdoor POS by April 2021. Beyond that date, any fraud committed because of the lack of an EMV-compliant device would shift from the credit card company to the gas station operator. This led to an EMV upgrade cycle that peaked in 2020 and was expected to tail off in 2021 and beyond. While the company disclosed that peak to trough revenue was expected to be $400-500mm, it had never given a clear guidance on the cadence of the decline. Interestingly, 2021 and 2022 saw lower rates of decline from EMV revenue relative to guidance but on Q4 2021 earnings call, management revealed that 2023 would see a total drop-off of $300mm to $350mm, a material increase from 2022’s expected headwind and more drastic than the Street expected. 2022’s overall guide came in above expectations with stronger non-EMV growth and milder EMV decline expectations but 2023 and 2024 EBITDA estimates were rebased below 2022’s guide. While management indicated that it could make up more than half of the ~$325mm decline with organic growth, absent any M&A, VNT lacks earnings momentum heading into 2023.
In our view, this 2023 EMV guidance is less concerning than what the market suggests. First, Dover (ticker: DOV), a competitor in refueling equipment, indicated that historical precedent from the implementation of EMV in Europe and Canada suggests a revenue tail that is smoother (i.e. no sudden drop in 2023). Second, VNT has been conservative in its initial forecasting of EMV declines in 2021 and 2022; both forecasts subsequently saw positive revisions. Third, while EMV has been a tailwind to GVR growth over the last several years, payment regulation in the US is just one of many growth drivers and VNT has grown on an ex. EMV basis. Bottom line, given our valuation utilizes 2023 EBITDA driven by a conservative EMV guide, we believe our thesis fully bakes in this news.
Other potential causes of the selloff may include questions over capital allocation and VNT’s ability to execute accretive M&A at reasonable multiples. DRB, purchased at 19x EBITDA, may cause some sticker shock; our view is that the high growth, tech-enabled business is accretive to VNT’s financial profile, which along with precedent transactions multiples, justifies the purchase price. In addition, VNT’s dilutive acquisition of Driivz and commitment to do $500mm in ‘energy transition’ investments over the next 5 years may slow earnings growth. Our view is that VNT is making measured investments in EV infrastructure that will position the company for better growth in the medium and long term. Looking forward, VNT has signaled a greater focus on more DRB type acquisitions than Driivz type investments, which should be an earnings tailwind.
Management Signaling – Change in Capital Allocation
“Vontier is in the midst of a multi-year portfolio transformation, and this ASR reflects our strong conviction in the business, its growth prospects, and the strength of its free cash flow as we reposition Vontier to lead in the energy transition and solving next-gen mobility and transportation challenges” – CEO Mark Morelli ASR Press Release
The overall weakness in VNT’s stock combined with a 20% decline around Q4 2021 earnings resulted in a material shift in capital allocation. While VNT had a $500mm share repurchase authorization in place since May 2021, it was previously not utilized. Per the CEO, the $250mm ASR announced 5 days after earnings ‘reflects our strong conviction in the business, its growth prospects and the strength of its free cash flow.’ Meanwhile in early March, after a series of investor conferences, VNT’s CEO and CFO both bought stock, purchasing 11K and 8.5K shares respectively at a weighted average price between $23 and $24. For a business whose modus operandi is to deploy capital into accretive M&A, this shift in capital allocation to share repurchases is strong signal, especially considering the SOTP discount.
Separately, the CEO hinted that the management ‘could identify parts of the portfolio that are outside our consolidation’ suggesting potential for divestments as a source of capital. We fail to see the strategic relevance of both GTT and Teletrac Navman (non-GVR MT businesses) and believe those could be interesting divestment candidates. Further, given DIRT is not a core area of focus for future M&A, we believe that could make for an even more sizable divestment. We think any sales that could simplify the portfolio and allow for either additional shareholder returns or more strategically relevant M&A.
Compelling Valuation and Risk-Reward
‘We agree with you, there's been kind of a dislocation of value. And especially in recent months here, we've seen stock trade at what feels to us like a significant discount to the intrinsic value of the stock. And that's why you heard us come out on this call and say we would opportunistically be looking to buy depending on market conditions.’ – CFO David Naemura Q4 2021 Earnings Call
At 8.5x our 2023 estimate of (trough) EBITDA, VNT trades at a wide discount to peers despite its top tier financial profile. On the MT side, Dover (ticker: DOV) and Franklin Electric (ticker: FELE) have similar exposure to fuel dispensing equipment though it represents a smaller proportion of their revenue. Given its conservative EMV guide, VNT’s expected growth lags DOV and FELE, though its historic growth, margins, returns and FCF profile all compare favorably. While we prefer not to model in any M&A, VNT does need to be credited for its FCF (2022-2023 totaling ~$900mm), whose yield is double that of these peers, and will be used to fund accretive M&A. With DOV and FELE trade at 14x 2023 EBITDA, VNT should trade at a discount but not as severe as what is currently priced in. At a blended (average of our bull and bear cases) multiple of 11.5x EBITDA, we value this business at a 20% discount to these peers. Another way to value this business given its ICE exposure is to compare it to gas station operators Casey’s General Stores (ticker: CASY) and Murphy’s USA (ticker: MUSA), which trade at 10.5x 2023 EBITDA. With VNT having better business/financial profile and lower ICE exposure, this multiple should represent a floor for valuation and is used in our bear case.
On the DIRT side, the best comp is Snap-On or SNA, which trades at 10x 2023 EBITDA. Taking a half turn discount, we value VNT’s business at a blended multiple of 9.5x. Combining both pieces, our bear case valuation implies a $32 stock or 28% upside while our bull case valuation implies a $40 stock or 60% upside. An average of these two cases yields a $36/share, representing 44% upside. Another way to think about valuation is to compare FCF yields. With the broader multi-industrial sector trading at 18x 2023E FCF, VNT’s 9x 2023E FCF is a clear outlier and given its favorable financial profile, it should trade more in-line. At 18x 2023E FCF, VNT would trade at $50 or double today’s stock price.
As a kicker, VNT has two assets that are likely not being properly valued by investors. First, in the DRB transaction, VNT acquired a $130mm (NPV) tax asset, which will augment FCF. Second, through a prior minority investment, VNT owns roughly 16% of Tritium (ticker: DCFC), a publicly traded manufacturer of direct current fast chargers for electrical vehicles. At a current market cap of $1.15bln, VNT’s stake is worth $188mm. Tax effecting that at LT capital gains and adding the tax asset yields $280mm in incremental value or ~$1.70/share.
Tying it all together, we believe that there are multiple catalysts for a re-rating. First, we see continued execution, particularly with DRB, as giving additional credibility to VBS and management’s ability to grow and diversify its powertrain exposure. Second, we see the two-year anniversary post spin in October 2022 as giving management additional flexibility for either more aggressive shareholder returns or additional transformative M&A. Third, now as an independent company, we see additional opportunity for management to prune non-core assets that would simplify the story and generate significant proceeds. Finally, given the recent ASR, related management messaging and insider buying, we believe the timing is right and that current levels provide a compelling risk/reward.
Appendix: Income Statement
Appendix: SOTP Valuation
Appendix: Comps Analysis