Teledyne (TDY) just surfaced on my screen, as the company announced another bolt-on acquisition, this time acquiring Illinois-based Quantum Data. While this particular deal is quite small, it underlines the strategy to make bolt-on deals and move into high margins businesses.
Similar deals in the past, great portfolio management and long term organic growth in attractive end-markets, have served long term investors well. After shares have been lagging a bit, given some temporary headwinds, I think that current levels still offer a decent opportunity for long term investors.
Teledyne describes itself as a high technology industrial business. The company nowadays generates half of its sales from instrumentation sales related to marine, environmental and test & measurement markets. The aerospace and defense business generates little over a quarter of sales, while the company has a real presence in digital and imaging as well.
This results in great diversification in terms of end markets, with activities being subdivided across three divisions which each post EBITDA margins of 17-20% per annum. The company generates half of its sales from the US, but a half of these sales are derived from the US government which can be problematic if defense cuts are being announced. Another headwind is the fact that a quarter of sales are derived from the offshore energy, infrastructure and transportation markets.
The exposure to the defense budget and energy markets create some headwinds which are being reflected in the current results. That said, Teledyne is making continued progress in order to diversify its business across geographical regions and end-markets.
Transforming The Business
Back in the year 2000, Teledyne was just a $800 million business which generated nearly two-thirds of its sales from aerospace & defense markets, a percentage which has dropped towards 25% by now.
The company has grown sales towards $2.3 billion in 2015, nearly tripling sales over this 15 year period. This translates into average growth of 7% per annum which is pretty decent. It should furthermore be said that the outstanding share base has been flat over this period of time, translating into similar growth in terms of revenues on a per share basis.
As the company has aggressively cut back its aerospace & defense activities, at least in percentage terms, it has built some real new businesses. Digital imaging has become a new activity for the company, while the instrumentation business has grown from 5% of sales in 2000 to nearly half of total sales by now.
This transformation has paid off big time in terms of margins and profitability. Gross margins have improved by 15 points to roughly 38% of sales. Even as operating expenses as well as R&D expenses have been on the rise, this has translated into a decent jump in operating margins of the business.
How Has Teledyne Achieved This Growth?
Improved diversification and a 7% revenue compounded annual growth rate has been very beneficial for both earnings and thereby long term returns for investors.
The real impressive thing is that this growth has been achieved while Teledyne has made a huge transformation in its portfolio. This transformation has been made through the purchase of roughly 50 businesses over the past 15 years, in total amounting to $2.1 billion.
The company has a little bit more room to make deals. At the end of 2015, Teledyne held $85 million in cash, while debt stood at $782 million if you include lease obligations, for a net debt load of $700 million. Adjusted EBITDA totaled $373 million in 2015 which translates into a leverage ratio of 1.9 times.
The company has been using the financial ¨room¨ to engage in more dealmaking into 2016. Besides acquiring Quantum Data, Teledyne has purchased Caris and Frontline Test Equipment in recent weeks, all for undisclosed amounts.
A Great Business, With Some Headwinds
Who does not like a well-diversified business which is reporting a 7% sales CAGR, accompanied by higher margins? Shares of Teledyne have risen from $10 in the year 2000, when the transformation started, to a high of $110 in 2015. Shares have now have retreated by a fifth towards $90 per share, still creating huge returns for long term holders.
That being said, shares are essentially trading at similar levels for three years in a row now, as the company has been hit by some headwinds from defense exposure as well as exposure to energy markets. This resulted in a 3.6% drop in fourth quarter revenues, more or less in line with the 4% annual decline in revenues for the entire year of 2015.
While this had a modest impact on margins, the company has been buying back shares to offset the decline in earnings per share, after the company kept the outstanding share base flat for a long time.
Despite the current headwinds, the company is still earning roughly $5.50 per share each year. With shares trading at $90, this translates into a 16-17 times earnings multiple which seems fair. That being said, 2016 is likely to be challenging with energy creating intensifying headwinds, prompting management to guide for earnings of just $5.10 per share, plus or minus five cents.
It should be said that this outlook does assume a worsening energy market, and this was based on the conditions in early February. Ever since, energy markets have rebounded somewhat as the dollar has lost some strength, creating potential upside to the guidance. Even if the outlook is correct, the multiple increases to just 17-18 times earnings.
What's The Value?
The 17-18 times earnings multiple translates into a reasonable 5-6% earnings yield, as investors should not expect to receive any of these earnings in the form of dividends. The company has good reasons to not pay out dividends, as the transformation and combined growth strategy has worked out very well for long term investors.
While shares are not outrageously cheap, as the earnings multiple is more or less in line with the multiples at which Teledyne has traded in the past, there are some points to be made. This relates to general valuation multiple inflation by the entire stock market, as interest rates have gone down. With Teledyne´s valuation being in line with the past, and shares having lagged the market by 15% over the past year, I see both absolute and relative value here.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.