Fortive: Creating Synergies Derived From Acquisitions

Summary

• Fortive had a strong beat on earnings on top and bottom along with solid guidance.
• The company's use of acquisitions to create growth through synergy with its core business will create long-term value.
• Assuming my DCF assumptions, Fortive is currently overvalued resulting in a hold rating.

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Over the past few years, Fortive Corporation (NYSE:FTV) has exhibited robust sales growth, resulting in a financially sound company with ample growth opportunities. While I acknowledge the company's acquisition strategy aimed at generating long-term share appreciation, my DCF projections indicate that the stock is overvalued. Therefore, I rate the company as a hold.

Business Overview

Fortive Corporation has over 18000 employees and designs, develops, manufactures, markets, and services professional and engineered products, software, and services worldwide. The company operates within 3 main segments which include: intelligent operating solutions to provide complex instrumentation and software services, precision technologies to provide testing and sensing for electrical equipment, and healthcare solutions to provide workflow solutions such as sterilization and tracking software.

Fortive Sales Overview (Annual Report)

With a market capitalization of $22.585 billion, a 52-week high of $69.78, and a low of $52.47, a price of $63.86 with a 29.92 P/E for Fortive displays a price that is close to their 200-day moving average and possibly overvalued due to their high P/E.

Fortive Corporation pays a modest dividend of 0.44%, with a payout ratio of 13.11%, which provides the company with enough financial flexibility to pursue its capital expenditure plans aimed at differentiation and expansion. The company has also issued a limited number of shares, which I view positively, as the shares appear to be somewhat costly at the current price level, and the funds raised can support the company's ongoing efforts to enhance its operations through innovation and acquisitions, resulting in increased cash flows in the future.

Seeking Alpha

Fortive Annual Shares Outstanding (Trading View)

With Q1 2023 results exceeding expectations on the top and bottom lines with a 2.58% beat on earnings per share ($0.73 compared to $0.75) and a 2.71% beat on revenue ($1.42 billion compared to $1.46 billion), the company is displaying outperformance in a time of slight moderate economic headwinds. Fortive also maintained 2023 guidance of low to mid-single-digit growth through 2023 along with ~75 bps margin expansion. I believe that this maintained growth along with the company's goal to have a strong balance sheet will hedge against risk while accumulating FCF from operations to acquire firms in the near future.

Investor Presentation

Fortive Compared to the Broader Market

In the past three years, Fortive has underperformed the broader market which explains their strategy to now employ FCF more efficiently and expand in growing segments. I believe that with this slow performance, growth seems to be catching up to share price and we may see great performance from Fortive in the near future.

Fortive Compared to the S&P 500 3Y (Created by author using Bar Charts)

Strategic Acquisitions to Drive Efficiency and Growth

Historically, Fortive has done a fantastic job of integrating new acquisitions and innovations into its core business model. These improvements have allowed the company to scale along with improving its profit margins driving its FCF forward. This increase in FCF has given the company flexibility to invest in new avenues as well as utilize rapid technological advancements to its advantage. Two examples of acquisitions to improve operations and will synergize well with their core business model are Provation Software and ServiceChannel both in 2021.

ServiceChannel was acquired in July 2021 for $1.2 billion and is a leading global provider of SaaS-based multi-site facilities maintenance service solutions with an integrated service-provider network. With revenue expected to be approximately $125 million and growth at a CAGR of mid-teens, the company has a bright future ahead and is a great addition to the company's core revenue segment.

Provation Software was also purchased for $1.425 billion from Clearlake Capital Group, L.P. in December 2021. Provation provides innovative solutions to enhance clinical productivity, care coordination, and reporting and billing accuracy in order to consistently deliver high-quality patient care. The company serves more than 5,000 customers and is expected to have 2021 revenues of approximately $110 million.

These two purchases exemplify Fortive's goal to synergize their business and create a more diversified, long-term business strategy that will pay off in the future. These acquisitions will be able to synergize with their existing operations and provide the company with further reach and improvements in services which will help them differentiate from competitors. With a recent bid of $60 per share on National Instruments, Fortive shows no signs of slowing down on its acquisition strategy which if integrated correctly, will be very successful.

Provation Overview (Company Website Overview)

Analyst Consensus

According to analyst consensus, Fortive Corporation is considered a "buy." Despite being overvalued as discussed later in this article, the stock still offers substantial potential returns, as evidenced by the average price target of $75.44, representing an upside of 18.13%.

Trading View

Valuation

Before creating my assumptions and calculating my DCF, I will calculate the Cost of Equity and WACC for Fortive using the Capital Asset Pricing Model. Factoring in a risk-free rate of 3.57%, I was able to conclude that the Cost of Equity was 7.81% as displayed below.

Created by author using Alpha Spread

Assuming this Cost of Equity value, I was able to calculate the WACC to be 7.56% as shown below, which is under the industry average of 9.94%.

Created by author using Alpha Spread

Utilizing a Firm Model DCF analysis with FCFF but without considering CapEx, I have concluded that Fortive Corporation is currently overvalued by 28%, given a fair value of approximately $45.94. To arrive at this valuation, I used a discount rate of 7.56% over a 5-year period, as well as assumed a mid-single-digit revenue growth rate beyond 2023, which is in line with the company's projections.

5Y Frim Model DCF Assumptions With FCFF and no CapEX (Created by author using Alpha Spread)

Capital Structure (Created by author using Alpha Spread)

Risks

Economic downturns: Fortive's performance is closely tied to the general state of the global economy, and a prolonged recession or economic slowdown could have a significant impact on the company's revenue and profitability. This will hinder the company's ability to accumulate FCF for acquisitions and improvements and possibly block the integration of current acquisitions leading to stagnant growth.

Manufacturing and Supply Capacities: Since Fortive purchases materials, components, and equipment from third-party suppliers to support its manufacturing operations, several adverse impacts on the company's income may arise if they fail to adjust its purchasing and supply chain management in response to disruptions or changes in customer demand, market fluctuations, or other external factors. Such disruptions may include supply chain or transportation disruptions, geopolitical conflicts like the Ukraine/Russia conflict, severe weather events, labor shortages, seasonality, or cyclicality. The COVID-19 pandemic may also contribute to these disruptions. This is a major risk for Fortive as it purchases materials from a handful of suppliers meaning that if competitors have greater access to the supply chain, they will have the ability to steal customers from Fortive due to reliability concerns.

Conclusion

In summary, I consider Fortive Corporation a hold at present due to its fast-paced acquisitions and advancements in its primary business model, as well as its overvalued share price. However, I am optimistic that if the valuation becomes more reasonable, upgrading the company to a buy rating would be a viable option.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.