Fortive Corporation Building A Conglomerate For Connected Workflow Solutions

Summary

• Fortive Corporation was spun off from Danaher in 2016 and, like Danaher, follows a business and manufacturing playbook it calls the Fortive Business System.
• It reported 4th quarter and 2022 full year results on 2/1/22 and delivered double-digit revenue and earnings per share growth on both a quarterly and full year basis.
• Full year 2022 and Q4-2022 free cash flow grew 28% and 62%, respectively.
• Trailing returns lag the market, but Fortive expects +75 bps operating margin expansion in 2023 along with $3.33 adjusted earnings per share (at the midpoint) in 2023. At current prices, Fortive trades at a 19.8 forward earnings multiple, below its 22.19 5-year average.

Drazen_/E+ via Getty Images

Company Overview

Fortive Corporation (NYSE:FTV) was spun off from Danaher Corporation (DHR) in July 2016 and began trading publicly on the New York Stock Exchange. Currently, the company operates and reports financial results in three segments:

• Intelligent Operating Solutions (42% of FY22 revenue)
• Precision Technologies (35%), and
• Advanced Healthcare Solutions (23%).

In each segment, Fortive owns a number of brands that sell products and solutions to customers in their respective markets. For example, in its healthcare segment, Fortive owns ASP (Advanced Sterilization Products), which markets infection prevention solutions for healthcare. One of its key products is a Sterrad Velocity System that has a 15-minute time to read (the industry's fastest), which delivers sterilized instruments to operating rooms quicker and more accurately.

The largest segment - Intelligent Operating Solutions (IOS) - uses advanced instrumentation to ensure safety and compliance, improve energy efficiency, and optimize building performance. Some brands under this segment include Accruent, Fluke, Gordian, and ServiceChannel, among others.

Precision Technologies, Fortive's second-largest segment by revenue, solves technical challenges for engineers and product developers in a wide range of applications including food and beverage production and communications and clean energy. In this segment, Fortive operates brands such as Anderson-Negele, Gems, Setra, and Pacific Scientific.

Finally, Fortive's healthcare segment provides a number of solutions for the delivery of healthcare, including instrument sterilization, biomedical test tools, and radiation safety monitoring, among others. Brands under this segment are the aforementioned ASP, Censis, Evotech, and RaySafe as well as several others.

Critically, Fortive's key shareholder proposition is

1. compounding cash flow by redeploying free cash flow into acquisitions, and
2. its commitment to the kaizen methodology.

Developed by Masaki Imai in his book Kaizen: The Key to Japan's Competitive Success, kaizen means continuous improvement and is Fortive's key organizational pillar across its businesses. Going forward, shareholder returns are likely to be driven by Fortive's ability to drive margin expansion in its businesses with the kaizen philosophy as well its ability to find and acquire complementary businesses to its existing brands in each business segment.

Recent Q4 Financial Results

Fourth quarter 2022 and full year 2022 revenue came in at $1.53B and $5.83B, respectively. Year over year, "core" revenue increased 14% in the fourth quarter and increased 10% for 2022. "Core" revenue excludes revenue from acquisitions over the time period and any currency impacts. Fortive saw low double digit growth annually across all geographies in which it operates (North America, Western Europe, and Asia). Interestingly, it saw mid-teen and high-teen revenue growth in Western Europe and Asia, respectively.

Adjusted operating margin was 25.5% for the fourth quarter and 24.3% for the whole year. In 2022, operating margins expanded 120 basis points year-over-year, and Fortive expects additional operating margin expansion in 2023 (see FY-2023 Outlook below).

Finally, Fortive showed robust growth in free cash flow ("FCF"). In the fourth quarter, FCF grew 62% to $428M, while full year FCF came in at $1.21B and grew 28%.

FTV Q4 and FY2022 Financials (FTV Investor Relations)

FTV Q4-2022 Revenue (FTV Investor Relations)

FY-2023 Outlook

In fiscal year 2023, Fortive expects core revenue to grow modestly in the range of 3% to 5.5%, while operating profit is expected to grow in the 5% to 10% range due to an expected increase in operation margins from 24.3% in FY-2022 to 25% to 25.5% in 2023.

FTV 2023 Outlook (FTV Investor Relations)

Financial Returns

Since its initial public offering in 2016, Fortive has lagged the market as measured by the S&P 500 (SP500). Interestingly, this underperformance is almost entirely since the start of the pandemic in March 2020. Prior to that, Fortive's returns kept pace with the S&P 500, and even at times exceeded it during the late 2018 to mid-2020 time period. Since the pandemic, however, Fortive stock has lagged.

Data by YCharts

Given Fortive's 2023 EPS guidance of $3.25 to $3.40, and current prices around ~$66 (as of market close on February 1), Fortive trades at 19.78 times forward earnings (taking $3.33 as the midpoint).

My Take

Overall, my assessment of Fortive as an investment is meh. While the growth in free cash flow in the fourth quarter and in FY-2022 was impressive, the revenue guidance for 2023 is light (3-5%), and so most of the profit growth has to come from reducing costs. True, Fortive does expect to increase its margins and, therefore, drive profit growth higher than revenue growth (at 5-10% operating profit growth vs. 3-5% for revenue). This appears positive, but I expect there is an upper limit to improving operating margins in the businesses in which Fortive operates. At some point, revenue would have to grow higher for investors to substantially benefit.

Additionally, this puts pressure on Fortive Corporation to use its free cash flow for acquisitions to spur revenue growth. This seems to me to be a high risk-high reward strategy. Instead of compensating shareholders in the short-term with dividends (Fortive's dividend has been fixed at $0.07 since September 2016) or share repurchases, the company will likely look to use its free cash flow to fund acquisitions which may be value accretive or destructive.

In the end, an individual investor has to evaluate the financial metrics of the company, along with its strategy, to determine whether an investment in Fortive Corporation shares is a reasonable fit given the investor's risk profile. My personal assessment is that Fortive Corporation does not yet have the track record to give full confidence that it can successfully execute against its compounding cash flow strategy.

Disclosure: I/we have a beneficial long position in the shares of FTV either through stock ownership, options, or other derivatives. 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.