Ametek Looking To Get Back To Meaningful M&A As Pandemic Challenges Ease
- Ametek is a leading player in a range of demanding, high-spec monitoring, testing, calibration, and control applications across a range of largely longer-cycle or acyclical end-markets.
- M&A has always been a major part of the growth story, with Ametek favoring smaller, lower-risk bolt-on deals where there is a meaningful post-deal margin improvement opportunity.
- Ametek isn't just an M&A story, as the company reinvests around 5% of its sales into R&D and continues to push its mix towards communications, sensing, and analysis.
- Ametek shares aren't a clear bargain today, but the company has shown it can drive value from its model and the shares aren't priced out of line with other high-quality industrials.
If you want to find things to complain about with Ametek (NYSE:AME), be ready to put in a little extra work. It's possible to fault the relatively low returns of capital to shareholders and the generally high multiples the shares trade at, but neither are particularly damning in my book.
Ametek has shown over and over again that it can identify value-adding M&A targets and then build upon those deals with strong margin improvement (a la Danaher (DHR) and Fortive (FTV)), while reinvesting in the businesses to maintain their competitiveness and pricing power. That, in turn, has driven strong revenue (6% annualized growth for over a decade), good margins, strong (and improving) FCF margins, and above-average returns to shareholders.
Ametek presents two challenges for more fundamentally-inclined GARP-style investors. First, M&A is core to the business plan, but challenging to model on a year-to-year basis. Second, the company is a cash-generating machine and rarely trades at what look like conventionally cheap valuations.
I am concerned about the potential future impact on the share price from today's low rates and somewhat stretched industrial valuations, but I believe Ametek is in that upper echelon of high-quality industrials, and I believe the prospective returns today (mid-to-high single-digits) are in line to slightly better than the peer group average, and Ametek still offers some relative value.
Not Really A Short-Cycle Leverage Story
Ametek should see better demand in 2021, but this isn't a short-cycle recovery story like Illinois Tool Works (ITW) or Parker-Hannifin (PH). A lot of the markets that Ametek serves are either mid-to-late cycle markets (aerospace, oil/gas, metals, power) or not particularly cyclical. This isn't really an indictment of the company, but it does mean that investors should temper their expectations for the same sort of strong year-over-year improvements they may seem from more short-cycle names.
Aerospace remains a large market for Ametek at around 10% of revenue, or likely closer to 15% in a more normalized environment. Commercial aerospace revenue declined 35% in the fourth quarter, and Ametek has taken the same hits to its business as other high-quality suppliers like Eaton (ETN), Honeywell (HON), and Parker, and there's nothing particularly problematic in the weakness that Ametek has seen.
Longer term, the company remains well-placed in the market. Ametek supplies a range of invaluable sensor and monitoring components, including systems for engine, fuel, and fluid monitoring, as well as cockpit data systems and controls, heat exchangers, and MRO components. Ametek is unlikely to see a big recovery in this business in 2021, but the destocking that has hit the sector should be largely over this quarter, and business should improve more significantly in 2022 (narrow-body) and 2023 (wide-body).
On the flip side, medical (around 15% of sales) has grown to become a much more significant end-market, having roughly doubled over the past year. Ametek's exposure here includes a range of components like cable assemblies and laser-machined/fine-machined parts, as well as scanning and imaging components, and motors. What interests me most, though, is the recent acquisitions into healthcare communications, including nurse call systems that help improve workflows while balancing patient needs and challenging staffing levels.
More commoditized, longer-cycle process end-markets like oil/gas and metals are more mixed. Metals capex should be getting a boost from strong pricing, but oil/gas is likely looking at a longer recovery. In both cases, though, these businesses have declined over time in their significance to overall sales (around 12% combined now).
A Strong, Proven Model
Have spent more than $4B on over 30 deals since 2012, it may be tempting to assume that Ametek is just a growth-by-acquisition story that will eventually stall and sputter once the company can no longer identify worthwhile needle-moving deals. I don't think that's the case.
For starters, Ametek has a disciplined M&A process. The company looks for players in oligopolistic markets/niches where there are credible barriers (or at least speedbumps) to competitive entry. Ametek also focuses largely on bolt-on deals that are in end-markets adjacent to existing businesses, reducing the risk from forays into the unknown. The company is also exceptionally good at driving post-deal margin improvements, often seeing meaningful first-year accretion.
Ametek also reinvests in what it buys, with the company historically spending around 5% of revenue on R&D. Ametek has built itself in large part on specialized high-performance equipment in test & measurement, analysis, sensing, and imaging, as well as power quality/control, communications, and precision motors, and those are segments/niches that reward (if not demand) ongoing product innovation.
As a conglomerate, Ametek typically devolves meaningful responsibility, control, and accountability down to the business units, with management focusing more on strategic capital allocation and overseeing the performance of those units (intervening where necessary, but otherwise not micromanaging).
The results are what they are. The company has generated mid-single-digit revenue growth for quite some time now, but has also generated strong (and improving) margins at the operating, EBITDA, and FCF margin lines, leading to over a decade of double-digit annualized FCF growth and double-digit ROICs, as well as double-digit (mid-teens) long-term annualized stock returns.
Because M&A is part-and-parcel of the model, year-to-year modeling can be a little more challenging. That said, Ametek doesn't usually look for especially large deals, though the recent $1.35 deal for Abaco is the largest deal in company history and clearly telegraphs a willingness to think bigger. I'm expecting Ametek to generate long-term revenue growth in the low-to-mid single digits on its own, with M&A likely layering in another 100bp-200bp of growth on top of that.
I also expect ongoing improvements in margins, as the company shifts towards more monitoring, sensing, communications, and analysis opportunities as opposed to conventional hardware. Over the last decade, the long-term FCF margin has improved from the low double digits (around 11%) to the high teens (around 18%), and I expect further improvement into the low-to-mid-20%'s, driving high single-digit FCF growth.
Investors looking for big capital returns to shareholders may not be happy here. Ametek pays a modest dividend has repurchased shares over the years, but management is clear that M&A is their priority for FCF allocation.
The Bottom Line
Ametek doesn't look all that cheap on conventional valuation approaches, and I wouldn't expect it to given the results management has produced and the opportunity to continue building value their M&A. I will say, though, that the prospective returns today (discounting back free cash flow) aren't any worse than the average of the high-quality industrial sub-group, and Ametek would arguably deserve a slight premium there (one of the "best of the best").
I am concerned that valuations are stretched for the group as a whole and that investors may be looking at pretty lackluster returns compared to historical norms, but I would still argue for Ametek as a name to consider for investors who want or need industrial exposure for the longer term.
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