gorodenkoff
AMETEK (NYSE:AME) is a manufacturer of electronic instruments and electromechanical devices, and their business has been driven by both organic growth and acquisitions. AMETEK owns a collection of niche industrial companies and maintains significant market share in these niche industries, affording them tremendous pricing power. I believe that AMETEK's performance-based, entrepreneurial culture makes them successful in these industry markets.
Organic Growth and Acquisition Growth model
Over the past decade, AMETEK has experienced tremendous growth in organic contributions and acquisition growth. When they acquire a business, they keep the business operating independently and maintain the acquired business's culture and leadership. AMETEK provides holistic corporate support to these independent businesses, including corporate budgeting, finance, human resources, and IT, among other areas.
AMETEK 10Ks
AMETEK's business model enables them to identify qualified acquisition targets with ROIC metrics exceeding 10%, and these acquired businesses contribute to their future organic growth. I would argue that AMETEK's M&A team is one of their key competitive advantages, and their execution of acquisition integration is superior.
AMETEK 2023 Investor Presentation
Pricing Power in Niche Industrial Markets
AMETEK is pursuing business development in niche industrial markets, maintaining a leadership position in each market they operate in. For example, Abaco Systems is a global leader in embedded computing for the most demanding applications in high-profile military and aerospace industries. I suspect that not too many people have heard about this company; however, Abaco's systems are widely used in these defense industries.
Due to their leadership in these niche industries, AMETEK has notable pricing power. In Q2 FY23, pricing contributed 5% to the total growth for AMETEK. Compared to their cost inflation of 4%, their pricing increase can more than offset any cost pressure. Even when inflation cools down in the future, I don't believe AMETEK is going to lower their prices for their products. As their management mentioned, they intend to retain the vast majority of pricing going forward. I believe AMETEK's pricing power is built upon their unique product solutions in these niche markets, and their business model is quite unique in nature.
Balance Sheet and Cash Flow to Support Acquisitions
Over the past five years, AMETEK has generated $5.6 billion in cash flow from operations in total. AMETEK follows an asset-light business model, with combined capital expenditures of only half a billion dollars over the last five years. Additionally, they have paid out $800 million in dividends and bought back $730 million worth of stocks. Approximately 70% of their free cash flow has been allocated to acquisitions. As of Q2 FY23, they have a very robust balance sheet, boasting $2.9 billion in liquidity and a net debt/EBITDA ratio of 0.8x. I would argue that AMETEK's balance sheet is extremely healthy, and they have ample resources for future acquisitions.
I would also anticipate that they will continue to pay dividends and repurchase their own stocks in the future.
Diversified End-Markets
Considering that AMETEK is an industrial company, investors need to assess earnings volatility and end-market exposures. AMETEK doesn't disclose their end-market breakdown. However, based on my past conversations with them, I trust that they have a highly diversified end-market exposure. My estimate is that Oil & Gas represents less than 5% of group sales, medical is close to 20%, aerospace is around 10%, military is about 7%, and most of their end-markets are exposed to general industrials.
Overall, I don't have concerns regarding their end-market exposures, and I believe they are well diversified. Furthermore, some non-volatile markets like Medical can provide some earnings stability for AMETEK.
Recent Results and Outlook
AMETEK delivered a very strong Q2 FY23 earnings. Organic sales growth was 5% in Q2, and M&A added 4% and foreign currency was flat.
AMETEK Quarterly Earnings
They expect mid-to-high single-digit organic sales growth for the full year of FY23, and diluted EPS is guided to increase by 9%-10% compared to last year. In Q2, they generated $335 million in cash flow from operations, marking a 42% year-over-year increase, and free cash flow surged by 47% year over year. As mentioned above, their balance sheet is exceptionally strong with very low debt leverage. I have confidence that AMETEK can deliver high-single-digit organic revenue growth over the next decade, and M&A should contribute more than 2% to total growth.
Key Risks
Elevated Inventory Level in Automation & Engineered Solutions: in Q2 FY23, their Automation & Engineered Solutions declined by mid-single digits organically. The management team indicated that the normalization of inventory levels is continuing across their OEM businesses, and the impact is most significant in the automation business. I believe it might take several quarters for AMETEK's distributors to work through these elevated inventories. For the full year, AMETEK is guiding the Automation & Engineered Solutions business to be up by low single digits, including acquisitions. Their management expects inventory normalization to reach its lowest point at the end of this fiscal year. I think their full-year guidance already accounts for the potential weakness in their automation business lines.
Commercial Aerospace: I believe AMETEK has low-single-digit revenue exposure to the commercial aerospace industry. They serve both the OEM market and the aftermarket. Aftermarket growth tends to be stable in nature; however, the OEM market is subject to the capital expenditure cycles of commercial aerospace companies. Given the persistence of high inflation, there could be potential weakness in travel, leading to a slowdown in capital expenditure by commercial airline companies. That being said, AMETEK has a well-diversified set of end-markets, and some industry cycles can offset each other.
Valuation
In the DCF model, I assume a 7% organic revenue growth rate and a 2% M&A growth rate for AMETEK. Due to their operating leverage and pricing power, I forecast that their operating margin will improve to 27.4% in FY32.
AMETEK DCF Model-Author's Calculation
AMETEK operates on a low-capex business model, and their free cash flow margin is notably high compared to other industrial companies. In the model, I estimate that their free cash flow margin will reach 25.1% in FY32.
AMETEK DCF Model-Author's Calculation
Their working capital, which includes inventories, is estimated to be 20.8% of revenue in FY32 in the model.
The model also utilizes a 10% weighted average cost of capital (WACC), a 4% terminal growth rate, and a 19.5% tax rate. The estimated enterprise value in the model is $37 billion, resulting in a fair value of $159 per share according to my estimate.
End Notes
I view AMETEK as a unique niche player in the industrial sector with a high operating margin and strong free cash flow conversion. Their combination of organic growth and acquisitions contributes to their ability to deliver superior free cash flow growth. Considering the valuation, I would assign a "Buy" rating for AMETEK.
