Nordson (NASDAQ:NDSN) is hardly alone in having a year to forget so far in 2022, with the shares down about 15% since the start of the year and lagging the broader industrial space. While companies like Parker-Hannifin (PH) aren’t great comps from a product line standpoint, they’re both businesses where the stocks tend to struggle once the Purchasing Managers' Index starts to soften, and this has been a common theme across the industrial sector in recent months, exacerbated by increased global economic uncertainty in the wake of Russia’s invasion of the Ukraine.
Industrial stocks got quite expensive, and I do think further derating is a risk, as are downward revisions to numbers if high energy prices and other cost pressures start impacting demand. Nordson won’t be immune to that in the short-term, but I do like the story here, given Nordson’s leverage to semiconductor capex, packaging capex, and growth opportunities in areas like biopharma and EVs. The share price isn’t where I need it to be yet, but this is definitely a name for a watchlist.
There wasn’t much to complain about in Nordson’s fiscal first quarter results. A larger beat on the top line would have been nice, but the margin performance was solid, particularly considering the cost environment, and it’s hard to complain about a revenue growth number that was double the average for the industrial space.
Revenue rose 16% in the quarter, with 12% growth in the Industrial Precision Solutions (or IPS) business and 21% growth in the Advanced Technology Systems (or ATS) business. Growth was strong across the business, but not surprisingly the electronics, industrial, and medical categories stood out.
Gross margin improved about 70bp from the year-ago level and 50bp from the prior quarter. While the business did benefit from a more lucrative mix (helped by a business sale), delayed realization on pricing actions led to about a point of negative price/cost pressure. Even so, adjusted operating income rose 44% (margin up 510bp to 25.8%), with incremental margin of 57% (most companies are happy with incrementals in the 30%s).
By segment, IPS rose 24%, with margin up almost three points to 32%, while ATS grew 62% with margin up seven points to just under 27%.
Given trends in Nordson’s major end-markets, I’m really not that worried about the prospects for Nordson’s growth over the next three to five years.
The electronics end-market is the largest one for the company at close to 30% of revenue, and while the semiconductor cycle may be starting to turn, I believe the outlook for capital equipment is still solid. Fabs like TSMC (TSM) and Samsung (OTCPK:SSNLF) have already announced significant capex programs to expand leading-edge capacity, Intel (INTC) is getting into the fab business, and Texas Instruments (TXN) recently announced that capex spending as a percentage of sales is going to triple over the next four years and still stay at double the historical rate thereafter for the rest of the decade.
While Nordson doesn’t participate in the front-end processes that get a lot of investor attention (think companies like Applied Materials (AMAT)), the company has a significant presence in wafer-level packaging and final assembly and packaging, and that area is going to get significant capex as well, with TI specifically calling out its intention to spend on this area, and outsourced assembly and test companies like Amkor (AMKR) likewise accelerating their capex plans.
While I’m not as confident that packaging will enjoy the same level of multiyear capex spending as semiconductors, there’s definitely a capex spending push here. E-commerce is driving more demand for packaging materials, while food and beverage companies are invested in new sustainable packaging technologies; these products still need Nordson’s automated adhesive and coating dispensing machinery.
Nordson’s opportunities in the medical and biopharma space are a little more nuanced. In the near-term, Nordson should have good leverage to recovering procedure counts as hospitals work through their backlog of deferred cases (including numerous catheter-based procedures); companies like Abbott (ABT) and Philips (PHG) have already talked about improvements here.
Longer term, I’m curious to see what Nordson can do in areas like bioproduction and life sciences. My understanding is that this isn’t a big part of the business today, but high-precision / low-volume dispensing technology should be applicable to those markets, as well as fluid connection components, and medical/science fluidics has been an important market for IDEX (IEX).
In the near-term, Nordson’s leverage to agriculture and construction machinery manufacturers should remain a positive driver, particularly with overaged fleets in the ag and construction markets and healthy demand conditions today. Longer term, Nordson’s leverage to automated dispensing technologies should give the company good exposure to EVs and batteries, as these will use more adhesives than mechanical fasteners.
I’ve discussed Nordson’s NBS Next program in the past, and won’t rehash it here, other than to say I think Nordson still has meaningful leverage to self-improvement initiatives relating to higher-margin growth. That’s particularly relevant if this weakness in the stock market starts translating into weaker M&A valuations and Nordson can get more active on that front (unlocking post-deal synergies by applying NBS Next to acquired businesses).
Input cost inflation was already an issue, and now Russia’s invasion of Ukraine has exacerbated the situation with even higher input costs (particularly energy). How resilient the global economy will be in the face of much higher energy prices remains to be seen, but spiking oil prices usually lead to negative economic consequences, so I’m getting more cautious on the outlook for later in 2022 and into 2023.
Longer term, though, I have no real concerns about Nordson’s growth potential, particularly given its leverage to semiconductor capex, packaging, and healthcare/bioproduction. I’m expecting Nordson to generate around 5% to 6% long-term annualized revenue growth, and I expect that to be complemented with stronger margins. I’m expecting Nordson to get its FCF margins into the low-to-mid-20%s on a consistent basis, driving FCF growth above revenue growth.
Between discounted cash flow and margin/return-driven EV/EBITDA, Nordson still isn’t “cheap”, but these shares rarely get there. Were the share to pull back another 10% to 15%, though, I think they’d start getting very interesting. Great companies rarely get all that cheap, but given the downturn in the market and the risk of some near-term negative revisions across the industrial sector, this is a name well worth watching for a chance to make an opportunistic buy.
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