MTD - Mettler-Toledo: Precision Maker Is Off The Marks

2023-10-01 07:09:25 ET

Summary

• Mettler-Toledo, a dominant player in weight instruments, has experienced significant valuation multiple compression due to a stagnant share price and lower earnings power.
• The company's sales have grown modestly over the years, with operating margins rising and share buybacks increasing earnings per share.
• Despite a falling share price, valuation multiples remain demanding at 26-27 times earnings, as higher interest rates reduce the appeal of investing in the stock.

Over the summer, I was weighing the potential of shares of Mettler-Toledo ( MTD ) , a premium and dominant player in the weight instruments. Mettler has seen continued growth, accompanied by share buybacks. These achievements and a stagnant share price has resulted in significant valuation multiple compression in recent times.

Over the summer, shares have lost a bit more ground, "backed" up by softer than expected second quarter results, with the core business and China seeing unexpected weakness. Given the lower earnings power, and higher interest rates, the overall price action has been quite decent, as I see no need to buy the dip above the $1,000 mark here.

A Recap

Mettler-Toledo is a manufacturer and marketer of precision instruments which are used in laboratory, industrial and food applications. The laboratory segment makes up more than half of sales, with industrial sales responsible for about 40% of sales, as the food retail segment is responsible for just about 6% of sales.

A $30 stock in the early 2000s broke the $1,000 mark in 2020, as shares peaked around the $1,700 mark late in 2021. The company had grown revenues by a relatively modest 35% in the decade leading up to 2020, with sales reported at $3.1 billion. This marked modest growth, but nothing too spectacular, although that operating margins rose a full five points to 25% of sales. Moreover, a quarter of the outstanding share base was bought back over this period of time, with all factors above making that earnings per share tripled over a ten-year period.

Even as shares have seen greater returns, the company was awarded ever higher valuations multiples, with earnings reported around $25 per share in 2020, translating into a more than 40 times earnings multiple at the time. These multiples expanded further as shares peaked in 2021, yet by the summer shares had retreated to $1,270.

This came as 2022 sales had advanced further to $3.9 billion, with operating earnings reported at $1.07 billion, and net earnings of $873 million working down to a $39 earnings per share number. The company guided for 5% sales growth in 2023 with earnings seen near $44 per share, translating into a 27 times multiple, while leverage ratios came in around 1.5 times. This was still a high multiple, certainly with interest rates on the rise, but it was a much lower multiple than at which shares traded in recent years.

Believing in the quality of the franchise and the long term framework to create shareholder value, I was quite upbeat as I would be willing to acquire shares at a 4.5% earnings yield, translating into an entry target of around a $1,000 per share.

Cooling Down

Since July, shares have fallen nearly 15% to the $1,100 mark here, creating more pressure on those valuation multiples. Later in July, Mettler posted second quarter sales of $982 million, up a mere 0.4% on the year before. Amidst modest margin expansion, net earnings rose by a percentage point to $214 million. Such earnings and a modest decrease in the share count made that diluted earnings rose by forty cents to $9.69 per share.

Net debt ticked up to $2.07 billion, mostly the result of the company executing on a quarter of a billion share buyback program, which still makes that leverage comes in below two times. The company guided for third quarter sales to fall by 3-4%, with adjusted earnings per share down 3-6%, mostly due to a 3% headwind from adverse currencies.

Moreover, weakness is set to last, with the full year earnings guidance cut from $43.65-$43.95 per share to $40.30-$41.20 per share. Not only has the guidance been cut in a meaningful way, the range has widened as well, as a testament to the uncertainty which the business faces. Both weakness in the core laboratory segment and China in particular have been key factors behind the downward revision in the guidance.

And Now?

The truth is that my $1,000 entry target needs some revision as the company has seen some real weakness. After all, the company has cut the full year guidance by some three dollars, a roughly 7% cut in the previous guidance. While share have moved lower in a more substantial way, multiples remain demanding at 26-27 times earnings.

Moreover, interest rates have only moved higher since July, raising the bar for an investment here, as quite frankly the entry price gets reduced to $900, even if I maintain the same 4.5% earnings yield here, with interest rates having moved higher in the meantime, as quite frankly the stock is still a bit overweight to see great appeal here.

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