Key Takeaways:
Fortive released good 2Q18 earnings, showing an acceleration in its organic growth rate into the high single digits (+5.3%), acquisitions added +7% to growth and FX +1.6%. While gross margin expanded 120bps, SG&A expenses impacted operation margin by 210bps (mostly from new companies having lower margins with a total impact of -70bps, and transaction costs lowering margins by another 60bps). Fortive’s core margin (removing the impact of M&A) expanded by 50bps, a good sign of the business’s strength. EPS grew 28% y/y. However, its 3Q18 guidance is below expectations (tariffs impact) and explains today’s stock weakness.
· 2Q18 comments showing the strength of the business: 5 out of the 6 platforms had positive pricing and core margin gains.
· Updated 2018 guidance: organic growth rate increase by 100bps (now 4-5%). As a result, core margins expected to gain 75bps (50bps prior guidance). EPS guidance raised as well on the lower end ($3.42 from $3.40). The updated guidance includes the $0.08/share impact from its mandatory convertible preferred stock offering, which should be offset by the strong operational improvements.
· Tariffs: $0.06/share negative impact in 2H18. This is higher than previously expected by management, but it should be offset. Tariffs explains the weaker margin outlook for 3Q18. Mitigation of tariffs will come from pricing (40%) and operational actions (60%) such as alternative sourcing, moving regional production and supply chain actions. So far they have seen no impact on the demand side. 2 sets of tariffs impacts them: steel (use for making the tool boxes for example) & electronics.
· M&A: the acquisitions from last year are finally lapping, and will be included in Fortive’s core organic growth, which should boost the growth profile of the firm by 20bps. M&A pace: CEO doesn’t think there is limitations right now. FTV always build capacity for deals from a talent perspective: they funnel talent to take on new opportunities. They have the people and financial capacity to bring on more businesses on board.
· ESG: CEO James Lico started his opening remarks on the call by mentioning the publication of their first CSR (Corporate Social Responsibility) report.
After review of our model, we are raising our price target to $87.
FTV Thesis:
– Market leader:
· Leadership position in most of the markets they serve
· Experienced leadership team
· Above industry margins with strong cash flows
– Quality:
· FCF yield ~5%
· Organic growth target of 3-3.5% (4-5% in last 2 quarters after being under the target in prior quarters)
· M&A strategy to enhance top line growth
· Margins expansion from new products introduction, continued application of the Fortive Business Systems and M&A integration
– Shareholder friendly:
· Management team focused on shareholder wealth creation through top line sustainability and margin expansion
$FTV.US
[tag FTV]
Julie S. Praline
Director, Equity Analyst
Direct: 617.226.0025
Fax: 617.523.8118
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