- Nordson posted particularly impressive incremental margins in the fiscal first quarter, leveraging a modest revenue beat into a sizable operating profit beat.
- Guidance for the fiscal year was pretty strong, with Nordson set to benefit from a broad industrial recovery and strong demand in electronics.
- Nordson is almost unassailable from a quality standpoint, but the share prices don't offer much of a bargain today.
It's been much, much too long since I've written on Nordson (NASDAQ:NDSN), but how many different ways can you say "this is a great company and I love the growth opportunities, but I don't really want to buy in at this price?" To that extent, this company is quite similar to names like Graco (GGG) in that it consistently does a good job, though with some cyclicality and not that much fanfare on the Street.
Since I wrote on the company back in 2017 (when I thought it was great but expensive), the stock has generated a total annualized return of 12.6% (including reinvested dividends) - just slightly below the 12.9% return of the S&P 500. This is my issue with overpaying - sometimes, with some companies, it works out, but often there's a price to be paid sooner or later.
This is a great company, and I still like the growth opportunities - particularly in areas like advanced semiconductor fabrication and packaging. I also like how management has expanded the medical business and adjusted the business model (NBS Next) to drive better growth over the next cycle. What I don't like, of course, is the valuation and this is a watchlist name for me for the next market freakout.
Stronger Fiscal First Quarter Results, With More Likely To Come
Nordson started off its fiscal 2021 year on a good note, delivering an impressive beat relative to sell-side earnings expectations. In the context of a broader industrial space where a lot of companies have been a little cautious relative to Street expectations, management also offered pretty solid guidance for the remainder of the year.
Revenue rose a little less than 3% on an organic basis (to $527M), beating by about 3%. The Industrial Precision Solutions (or IPS) business drove the beat with 6% revenue growth (to $288M), 9% better than expected, while Advanced Technology Systems (or ATS) saw a 1% revenue contraction to $238M that was 3% weaker than expected.
Gross margin improved 150bp to 55.1%, beating by about 130bp, and making for an excellent gross margin for an industrial that still primarily sells machinery (though consumables are more than half of the mix). Operating income rose 39% to $90M, with operating margin improving almost five points to 20.7% - operating income beat expectations by a strong 25%, as the incremental margins were exceptionally strong.
By segment, IPS generated 28.9% margin (up 740bp), beating by almost seven points, while ATS margin improved 450bp to 19.8% (a 260bp beat) on an organic revenue decline.
Backlog rose 7% in the quarter, covering almost a full quarter's worth of revenue ($495M). Management guided to 4% to 6% revenue growth for fiscal 2021, a little better than what most industrials have guided for, and I believe that is inclusive of the headwinds of the sale of the polymer processing screws and barrels business in December.
Multiple Attractive Drivers
About 40% of the segment revenue in ATS now comes from the medical business, and drug delivery was a strong contributor in this quarter. As procedure counts recover on fading pandemic pressures on the healthcare system, more procedure-driven product sales should accelerate through the remainder of the fiscal year.
Longer term, this remains an attractive growth business with attractive margins, and one that could easily absorb/support more M&A. Nordson runs this as a "behind the scenes" business for companies like Medtronic (MDT), and while top med-techs are usually reluctant to outsource core manufacturing, products like connectors, fittings, balloon materials, and so on are an exception.
Management also noted growth in test and inspection business within ATS, and I expect this to remain a strong business for Nordson in 2021. This business servs markets like PCB, electronics assembly, and semiconductor test and packaging, and with ongoing growth in data center spending, 5G deployment, 5G handsets, and so on, I'm not concerned about demand here.
While a lot of Nordson's business falls outside typical short-cycle industrial - electronics is about a quarter of the business, medical is close to 20%, and consumer is likewise about a quarter - the IPS business should benefit from a broader pickup in industrial end-markets and capex spending. Likewise, the company has meaningful leverage to packaging (consumer and industrial), and that business typically moves with overall consumption/demand.
If It's Not Broken, Don't Break It
There's little for me to fault in Nordson's basic approach to business. While there really isn't a good play here on hot themes like HVAC, industrial software, electrification, or automation, that's okay - Nordson succeeds as a facilitator, and the high level of customization and engineering that goes into many of products, not to mention the direct sales approach, leads to strong, long-term relationships with customers.
And that's not to say that there aren't any thematic plays here. I believe that with growth drivers like cloud computing (including AI/machine learning) and 5G, demand for leading-edge semiconductors is going to remain strong, driving healthy demand for Nordson's precision dispensing, soldering, cleaning, and inspection products in the semiconductor foodchain.
Looking at the business model, Nordson is showing some flexibility with the Nordson Business System to allow for more decentralization and localized responsibility, with the idea being to drive better/more acyclical profit growth over the coming years. I don't really see this as a threat to the margin or return profile.
I expect Nordson to generate mid-single-digit revenue growth over the next decade (annualized), and the company has the balance sheet flexibility to do more deals. Given Nordson's history and operating philosophy, I would expect M&A to be targeting at augmenting/expanding existing businesses and not new forays into unfamiliar markets/businesses.
On the margin side, I'm expecting some ongoing improvement from high-grading the product mix and driving more scale benefits and better asset utilization. I'm looking for long-term FCF margins to average close to 20% over the next decade, about four points better over the trailing decade, and that should drive high single-digit FCF growth.
The Bottom Line
None of my normal valuation approaches (discounted cash flow, margin/return-driven multiples) suggest that Nordson is undervalued, and I'm not all that surprised. I also don't see the sort of transformative growth here that would justify a "valuation doesn't matter" argument. While I'm a little concerned that the high valuation will preclude market-beating returns over the long term, I can appreciate Nordson as a "sleep well at night" stock, and it's definitely one I'd consider on a broader market pullback.
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