NDSN - Macro Risk Is Rising But Nordson's Diverse High-Margin Niche-Oriented Businesses Should Be More Resilient

Summary

• Nordson has benefited from strong demand in electronics and medical markets, but electronics capex demand could soften as lead-times shrink.
• Likewise, Nordson could be vulnerable to a broader slowdown in capex spending across many markets as companies catch up on backlogs and see moderating demand.
• Internal growth drivers, including investing in higher-potential organic growth opportunities, M&A, and margin improvement, are still very valid.
• Nordson is a good name to watch if and when the market gets even more negative on the macro outlook for 2023.

This is a tricky time to invest in industrials, and Nordson ’s ( NDSN ) multi-market diversification doesn’t really help now given the growing concerns about end-markets like semiconductors, consumer electronics, short-cycle industrial, and consumer non-durables. Likewise, this tends to be a capex-driven business with relatively little cycle visibility. On the other hand, this is a niche-oriented business with a proven track record of performance, and I like the company’s focus on managing for long-term performance (and not short-cycle optimization).

When I last wrote about Nordson , I wasn’t sold on the valuation, but thought the shares were worth watching. The shares subsequently declined about 10% through June before a sharp rebound and another recent fade that has left the share price more or less unchanged while the average industrial has lost about 10% of its value. I do remain concerned about valuation, particularly in the face of what could be a noticeable decline in capex investment over the next 12-18 months (especially in semiconductors and electronics), but this is definitely a name to keep on a watchlist and reconsider at/below $200.

Rearranging The Furniture To Highlight Growth

When Nordson next reports (fiscal fourth quarter earnings), the company will be re-segmenting the business to carve out the Medical Fluid Solutions business. Resegmentation doesn’t change the fundamentals of the business, of course, but it should make it more apparent that this is a high-growth business with good margins, and that could help burnish the company’s growth and margin credentials, and particularly so if cyclical businesses weaken more significantly in 2023.

I do also believe resegmentation could be a prelude to more capital deployment to build this business. I like the company’s existing business in fluid management components (tips, fittings, connectors, et al) that are used in a range of applications including biomaterial delivery (including stent coverings) and catheter manufacturing. I also believe, though, that Nordson’s core competencies in precision dispensing and fluid management could be applied to a broader range of life science and biopharma markets, as many advanced systems used in biopharma manufacturing, diagnostics, life sciences research, and drug delivery require on precision fluid measurement and transportation.

Semiconductors And Electronics – The Next Step Could Be A Doozy

Broadly defined, electronics markets (including semiconductor production) contribute around 30% of Nordson’s revenue. This has been a strong growth driver for several quarters (and over the long term as well), but semiconductor lead-times are shrinking, electronic component availability is improving, and consumer electronics demand is softening.

Long term, I still expect semiconductor demand to grow at a mid-single-digit rate, driven by growth in applications like auto, data center, and IoT, and I likewise expect many large-scale semiconductor fab projects to go forward as planned. Still, I do think the industry is heading toward a capex correction cycle as a recent rush to expand capacity post-pandemic runs into softening demand as companies catch up on their backlogs and see initial evidence of weakening demand.

To be clear, I have no meaningful concerns about Nordson’s leverage to electronics over the long term; indeed, I like the company’s efforts to expand its offerings here (including the somewhat recent CyberOptics ( CYBE ) acquisition that moves the company more into front-end applications). My concern is more about how the market can overreact to unwanted sector exposures in the short term, and how a relatively brief downturn in semiconductor equipment demand could impact reported organic growth here and the multiple.

The Outlook

It’s worth noting that there has already been some deceleration in the business. The last two quarters have seen organic growth shrink from 16% in fiscal Q1 to 7% in FQ2 and then 4% in FQ3. Granted, that last number is against a year-ago organic growth comp of 20%, the business is still seeing some impacts from COVID-related restrictions and lockdowns in China, and the company is going to set a new record high for revenue this year. Nevertheless, I expect analysts and institutions to really start focusing on the outlook for capital spending in electronics, consumer consumables, and industrial end-markets, as waning confidence and rising rates could drive a slowdown in 2023.

I am modeling a slowdown; I expect Nordson to exit this fiscal year with around 9% year-over-year full-year growth, but slow to around 3% to 4% growth in FY’23 ahead of a reacceleration in FY’24. Long term, I expect revenue growth around 5% to 6%, but Nordson could easily exceed this. Nordson has long been an active acquirer and between a very manageable debt situation and good free cash flow generation, I see no reason why they would stop. I do assume around 100bp to 150bp of growth from M&A in my model, already, but that could prove conservative, particularly given Nordson’s track record of building on acquisitions.

On the margin side, I do see room for further improvement from the NBS Next program, but I think EBITDA leverage will be relatively modest over the next two-plus years (around 50bp-70bp). I do expect FCF margins to reach the low-20%’s over time, though, helping to drive around 6% to 7% long-term FCF growth.

The Bottom Line

I value companies like Nordson primarily on discounted free cash flow, but I also use an EV/EBITDA approach driven by margins and returns (ROIC, et al). Discounted cash flow suggests Nordson is still pretty richly-valued, with an expected long-term total annualized return in the mid-to-high single-digit range. An EV/EBITDA approach using a 17x multiple (a premium to industrials in general, but supported by above-average margins, ROIC, etc.) supports a fair value closer to $239, but multiple-based approaches are much more responsive/sensitive to market sentiment.

At the bottom line, this remains a business that I like a lot, but one where I’m more cautious on the shares given valuation and the risk of sentiment souring on a weakening macro outlook for 2023. Should sentiment take the shares back toward $200 or below, though, this is a name I’d look to revisit, as I do believe the long-term outlook and strategy are both quite sound.

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