Roper Technologies may turn off some dividend investors because of its low starting yield. However, they are missing the forest for the trees.
The company achieves incredible compounding of cash streams by making its business increasingly profitable and asset light. It then re-invests its cash flow to help fund M&A.
The stock is almost never "cheap", and represents a rare case where "time in the stock" can be more beneficial than waiting for an entry price that may never come.
Software and engineered solutions company Roper Technologies, Inc. (ROP) can easily be misunderstood by the investment community. A dividend champion with a 26 year streak of increases, Roper Technologies is poised to offer investors many years of future income growth. A look below the surface makes it difficult to punish Roper for a low dividend yield that has been artificially suppressed by rapid share price appreciation. The company is a cash flow machine, and happens to be trading at a reasonable price today.
Dissecting The Dividend
Roper Technologies has increased its dividend payout each of the past 26 years. Yet, over the past 10 years, the dividend's yield has never once crossed 1%, and has not even come close to 10 year US treasuries - despite a historically low yield environment. The stock's consistently low dividend yield has repelled many dividend growth investors, especially those who look for some sort of minimum amount of yield on their investment.
However, all it takes is a little bit of patience to realize Roper's dividend potential. Over the past 10 years, the dividend has grown at an average rate of 19.0% each year. That means that your yield on cost is doubling every 3.8 years, a remarkable pace that can really add up over a long holding period. How do we know that Roper Technologies can maintain such a brisk dividend growth rate?
Despite the dividend paid per share skyrocketing from $0.34 in 2009 to $1.85 this year, the dividend's payout ratio has remained remarkably small. The annual dividend increased more than 5X, but the payout ratio (from a cash flow basis) has only increased from 9% to 13% over that time frame. As Roper Technologies continues to grow and raise its dividend, the nature of the math behind larger numbers will make this increasingly difficult to sustain. However, we conclude that long-term investors can take advantage of what should be many upcoming years of double-digit dividend growth that will compound their income significantly - despite a low starting yield. We simply need to look at how Roper's business operates, and the method to its growth to illustrate the reasoning behind our dividend growth outlook.
The Cash Flow Machine Behind The Dividend
Roper Technologies has been able to power its dividend by generating enormous cash flow streams. The company converts 26% of its total sales into free cash flow. In other words, 26 pennies of every revenue dollar goes straight into the company's cash pool. This type of FCF efficiency is driven by a couple of combined factors. First, you have the tactical management of Roper's business. Management strategically goes after business opportunities that are specialized. They often serve a niche need. They are typically market leading, and they generate recurring revenue streams.
source: Roper Technologies, Inc.
But perhaps most importantly, they are extremely asset light. The company spends about 1% of its revenue on CAPEX. Over time, management has squeezed more efficiency out of the company. Net working capital as a percentage of sales has been reduced from 18% to -3% over the past 15 years. Gross fixed assets as a percentage of sales have fallen from 20% to 8%. Roper is about maximizing margin and minimizing the resources needed to run its business.
source: Roper Technologies, Inc.
The other side of the equation is continued top line growth. The dividend only consumes 13% of free cash flow, and management spends little to no money on buying back stock. So where does the company put all of its generated cash streams? Roper Technologies has super-charged its top line growth by pouring its cash flow back into the company in the form of numerous acquisitions. These acquisitions have totaled more than two dozen over the years, and more than $10 billion in the past nine years alone. Not coincidentally, the company has focused on augmenting its Network Software/Systems and Application Software divisions - its two highest margin segments.
source: Roper Technologies, Inc.
As a result, the company has grown revenues at a CAGR of 9.6% since 2012. When you are growing revenues at a rapid pace with high margins, everything just begins to compound in your favor. Free cash flow has compounded at a 13.6% CAGR since 2012.
The company has wisely fed its cash flow into M&A agenda organically, rather than rely too heavily on leverage - a risk that companies are exposed to by trying to grow too quickly. The balance sheet has played a role in providing liquidity at times but as we can see below, management has continually paid down enough debt to maintain a solid balance sheet.
The company currently carries $323 million in cash against $6.2 billion in debt, a ratio of 19:1. Meanwhile, the current leverage ratio sits at 2.75X EBITDA. While technically surpassing our cautionary threshold of 2.5X, the company's growth and lack of FCF obligations free up enough cash to manage debt as necessary. Acquire, grow, re-invest. It's a cycle that Roper Technologies has gotten very good at executing.
Shares Are Reasonably Priced
The problem for many investors, is that a highly profitable and growing company such as Roper Technologies rarely trades at an attractive valuation. Over the past 10 years, the company's median earnings multiple has been a rich 24.91X.
While the stock market is currently at all time highs, Roper Technologies is actually off of its high. Still a long ways off of its 52 week low of $245 from January, shares currently trade at $343 versus a high of $385.
Management is guiding full 2019 earnings per share of approximately $13.00, which places the stock at an earnings multiple of 26.38X. This is obviously higher than the decade median P/E, but only by 6%.
Sometimes it just pays to be in a company for a longer period of time, rather than waiting for a perfect entry point. This is especially true for cash rich companies such as Roper Technologies. The low point we saw in January was by far the most attractive entry point of the past five years. The stock rarely ventures too far below 24X earnings these days.
When we last covered Roper Technologies in April, the stock was trading at a similar price point to today. At the time we advised a target entry of $288 per share with a neutral rating on the stock. While the stock has largely performed sideways since then, we are slightly modifying our stance on Roper's valuation. The company continues to expand its margins (gross margin up another 80 basis points this past quarter), and acquired another two software businesses. With a long-term holding period in mind, we are re-initiating our bullish rating as the long-term story is too good to turn away from.
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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.