Fortive: Cheap, Impressive Outlook, And Ambitious M&A Strategy

Summary

• Fortive Corporation expects a positive outlook for 2023 with impressive EPS and FCF growth expectations from 2023 to 2025, potentially through further acquisitions in the Precision Technologies business segment.
• The company has a clear balance sheet with manageable debt and potential for more debt for future acquisitions, market participants expect sales growth, operating margin growth, net margin growth, and FCF growth.
• Despite risks from supply chain constraints, changes in regulatory framework, and potential failed M&A transactions, Fortive's stock seems undervalued and could trade at a higher price.

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Fortive Corporation (NYSE:FTV) expects a beneficial outlook for 2023, and noted impressive expectations from 2023 to 2025 in terms of EPS and FCF growth. Already with exposure to proven business models and selling businesses in cyclical markets, in my view, FCF margin growth could come from further acquisition of competitors in the Precision Technologies business segment. Yes, I did recognize risks from supply chain constraints, which we saw in Q1 2023, changes in regulatory framework, or failed M&A transactions, however I believe that FTV could trade at a higher price mark.

Fortive Corporation

Headquartered in Everett, Washington, Fortive Corporation offers technologies for connected workflow solutions.

The portfolio is divided into three business segments, including Intelligent Operating Solutions, Precision Technologies, and Advanced Healthcare Solutions. Fortive also notes 5 workflows connected reliability, environmental health, facility and asset lifecycle, product realization, and perioperative loop. Management offered an extensive presentation to investors with many details about the present and future of Fortive.

Source: Presentation To Investors

Among all the documents given by management, I believe that the most interesting is the information provided about the future outlook. Management noted that it is operating in growing markets like the EHS market, connected reliability, and facility and asset lifecycle. Besides, with sufficient innovation and accretive reinvestment, Fortive expects to deliver an expansion of adjusted operating profit from 2023 to 2028.

Source: Presentation To Investors

I also believe that investors may appreciate having a look at the outlook given for the year 2023. Management expects revenue growth close to 3%-4.5%, adjusted operating profit margin of 25%-25.5%, adjusted EPS of 4%-8%, FCF conversion of about 100%-105%, and 2023 FCF of $1.25 billion.

Considering the results for Q2 2023, I believe that we could expect numbers close to the expectations given by management. 2023 sales are expected to be close to $1.48 billion, with an adjusted operating profit margin of 24.5% and FCF of $285 million. It is worth noting that Fortive usually gives results close to those expected by the market.

Source: Presentation To Investors

Very Clear Balance Sheet

Fortive reported cash and equivalents worth $672.8 million, trade accounts receivable less allowance for doubtful accounts of $$940.7 million, and inventories worth $570.2 million. I do not appreciate that the total amount of current liabilities stands above the total amount of current assets, however I believe that banks would most likely help if there is any liquidity problem.

Long term assets include property, plant, and equipment of $425.6 million, other assets worth $470 million, goodwill close to $9057.1 million, and total assets of $15.804 billion.

Source: 10-Q

With a current portion of long-term debt of about $999.8 million, trade accounts payable of $593 million, and other long-term liabilities worth $1204.4 million, the long-term debt stood at $2.094 billion.

Source: 10-Q

I reviewed the total amount of debt, and I do not think it is worrying at all. The company pays close to 3.15% interest for unsecured notes due 2026 and 4.3% interest for unsecured notes due 2046. I believe that Fortive could receive more debt for acquisitions in the future.

Source: 10-Q

Market Expectations

I believe that it is worth having a look at the expectations of other financial analysts. They seem quite beneficial. Market participants expect sales growth, operating margin growth, net margin growth, and FCF growth.

2025 net sales would stand at $6.856 billion, with 2025 EBITDA of about $1.962 billion, 2025 EBIT of $1.403 billion, 2025 net income of $1.168 billion, and 2025 free cash flow of about $1.916 billion.

Source: Marketscreener.com

DCF Model

I am optimistic about the future of the business model of Fortive because management continues to expect increasing demand. In the last annual report and the last 10-Q, the company noted beneficial expectations about demand generation. My DCF model includes some of these beneficial expectations.

We anticipate increasing demand for our offerings will continue and are projecting full year sales to grow on a year-over-year basis by approximately 2.0%-4.5% with year-over-year growth from existing businesses of approximately 3.0%-5.5%. Source: 10-k

Under my financial model, I assumed that the company will continue to acquire and develop proven business models as well as exit those activities that seem a bit cyclical. Besides, with growing recurring revenue, I believe that more investors will have a look at Fortive, which may enhance future stock demand. As a result, I would expect lower cost of capital and FCF generation. The company touched these initiatives among others in the following slide.

Source: Presentation To Investors

With regards to the acquisition of other small competitors, it is worth noting that Fortive has a significant amount of expertise in the M&A markets with close to $2.5 billion in revenue acquired and $7 billion in net capital deployed from 2016 to 2023. It is also worth noting that the company expects cash return accelerating in the next 5 years and FCF margin improvements from the M&A activities.

Source: Presentation To Investors

Among all the activities executed by Fortive, I would expect further improvement of the exposure to the advanced healthcare solutions business segment. I appreciate this business segment quite a bit as it is expected, in 2023, to offer close to 70% recurring revenue and a total addressable market of close to $10 billion.

Source: Presentation To Investors

For starters, Fortive appears to execute a significant number of divestitures, so we may expect more transactions in the coming future. The sale of Therapy Physics or the separation of Vontier seems to serve directly the interests of shareholders. In my view, as soon as more investors learn about these initiatives and the potential for cash from new transactions, the demand for the stock could increase.

We continually assess the strategic fit of our existing businesses and may divest or otherwise dispose of businesses that are deemed not to fit with our strategic plan or are not achieving the desired return on investment. Source: 10-k

On September 30, 2022, we completed the sale of our Therapy Physics product line, which was reported in our Advanced Healthcare Solutions segment. Source: 10-k

On October 9, 2020, we completed the Separation by distributing 80.1% of the outstanding shares of Vontier to our stockholders on a pro rata basis. Source: 10-k

In addition, I would also expect further revenue accumulation in activities that bring significant operating profit margin. In particular, I would appreciate further improvements in the Precision Technologies business segment, which offered, in 2022, an operating profit margin of close to 24.1% as well as growing sales growth. Further exposure in activities of larger operating margin would lead to larger implied stock valuation.

Source: 10-k

For the design of the future cash flow statements, I took into consideration some of the figures reported by Fortive in the last presentation to investors. In this regard, I believe that the following slide is quite relevant. The company expects double digit FCF growth and double digit EPS growth from 2022 to 2028.

Source: Presentation To Investors

My modeling of future cash flow statements includes 2033 net earnings from continuing operations close to $362 million, 2033 amortization of $826 million, 2033 depreciation worth $142 million, and stock-based compensation expenses worth $266 million.

Also, with changes in deferred income taxes of close to $60 million, changes in accounts receivable of about -$606 million, changes in inventories worth -$166 million, changes in trade accounts payable of $384 million, and changes in prepaid expenses and other assets of -$531 million, changes in accrued expenses and other liabilities stood at -$15 million. Finally, I obtained 2033 CFO of about $3.301 million, and with capital expenditures close to -$274 million, 2033 FCF would be $3.028 billion.

Source: DCF Model

In the past, the EV/FCF stood at close to 21x-23x, so I believe that EV / terminal FCF of close to 20x is reasonable. With these assumptions, I obtained an enterprise value of $38.232 billion.

Source: Ycharts

My model also resulted in EV/terminal FCF of 20x, terminal FCF of $58.840 billion, sum of FCF of $61.937 billion, WACC of 8.60%, and firm value of $38.232 billion.

Besides, with cash and equivalents of $672.8 million, current portion of long-term debt of $999.8 million, long-term debt of $2.094 billion, the target price would be $101.

Source: DCF Model

Risks From Failed Restructuring Initiated In Q1 2023, Failed M&A Initiatives, Lack Of Targets, Or Changes In The Regulations

Among the risks that I foresee for Fortive, I am a bit concerned about potential failures in the restructuring process that the company started in Q1 2023. In my view, facility consolidations and loss of key personnel could significantly damage future revenue and FCF expectations. A significant reduction in capacity could also be detrimental for future business growth. Management provided several details about these matters in the last quarterly report.

We initiated a discrete plan in the first quarter of 2023 focused on improvements in our operational efficiency, which is expected to be completed by December 31, 2023. The nature of these activities were broadly consistent throughout our segments and consist of targeted workforce reductions and facility consolidations or closures in response to overall macroeconomic and other external conditions. We incurred these costs to position ourselves to provide superior products and services to customers in a cost-efficient manner, while taking into consideration the impact of broad economic uncertainties. Source: 10-Q

Under the traumatic conditions, I believe that failed M&A transactions, goodwill impairments, or lack of M&A targets at beneficial good valuation would lower inorganic growth. Even with expertise in the M&A markets, anything can happen during the merger integration process. Finally, considering the total amount of goodwill, which is worth close to $9 billion, the likelihood of seeing some failed M&A is elevated.

I believe that supply chain issues will most likely continue during 2023. In the last quarterly report, management noted that even applying the Fortive Business System, the company continues to suffer some supply chain complications, which may bring challenges in the near future. As a result, I believe that the company may lose clients, or may see a deterioration in the FCF margins.

Supply chain issues persisted in the quarter, resulting in lingering challenges with logistics, material availability and absenteeism. We continue to apply the Fortive Business System to help mitigate the impact of these challenges and to serve our customers. We anticipate that the disruptions which began with the pandemic will continue to impact future periods. Source: 10-Q

It is also worth noting that Fortive could suffer significantly from changing regulations or more specifically from changes in the federal healthcare program, such as Medicare or Medicaid. It is also worth noting that changes in the application of the U.S. Federal Anti-Kickback Statute could affect some of the business segments operated by Fortive.

We are subject to various healthcare related laws regulating fraud and abuse, research and development, pricing and sales and marketing practices, and the privacy and security of health information. In particular, the U.S. Federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving, or providing remuneration (including any kickback or bribe), directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing or arranging for a good or service, for which payment may be made in whole or in part under a federal healthcare program, such as Medicare or Medicaid.Source: 10-Q

Conclusion

Fortive Corporation expects growing demand in 2023, and offered impressive expectations with regards to 2028 FCF growth. I think that further exposure to the Precision Technologies business segment, which offers growing and double digit operating profit margin, could enhance the total FCF margin of Fortive. Besides, further accretive acquisitions and divestitures, which management promised in previous presentations, could have a beneficial effect on future cash flow statements. I do see risks from supply chain constraints, changing regulations in the United States with respect to Medicare, or failed M&A transactions, however I believe that the stock does trade undervalued.

Analyst’s 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.