2023-12-27 13:28:20 ET
Summary
- IDEX Corp., a $16B industrial giant, excels in niche markets with consistent growth, strategic acquisitions, and impressive financial metrics.
- The company has a modest 1.2% yield, a 30% payout ratio, an 8.7% five-year dividend CAGR, and financial resilience.
- Given its growth potential, I'm bullish on the company and believe it is in a great spot to outperform the market on a long-term basis.
Introduction
Let's start this article by showing you the chart below.
Below, you're looking at the chart of a stock that has been in a consistent uptrend since the early 2000s, with increasing volatility since the pandemic.
As the watermark already may have given away, you're looking at the ratio between the total return of IDEX Corporation ( IEX ) and the S&P 500 ETF ( SPY ).
I started covering IDEX (please do not confuse this with the veterinarian healthcare giant IDEXX Laboratories ( IDXX )) in June of this year, as I was impressed by the ability of this low-yielding stock to compound shareholder value.
Hence, after half a year, I'm taking another look at IEX, as I am very eager to buy it if I get a correction opportunity in 2024.
So, let's get to it!
A True Wealth Compounder
With a market cap exceeding $16 billion, IEX is one of America's largest industrial companies.
The company operates globally through more than 50 wholly-owned subsidiaries, which are committed to embracing its 80/20 principle and prioritizing customer service in the market for highly engineered industrial solutions.
This is what I wrote in my prior article (emphasis added):
As we can see below, IDEX has three reportable segments : Fluid & Metering Technologies ("FMT"), Health & Science Technologies ("HST"), and Fire & Safety/Diversified Products ("FSDP").
These segments are structured to best serve customer needs and provide management efficiency, aligning with organic growth, strategic acquisitions, and capital allocation priorities.
- The FMT segment designs and distributes fluid-handling pump modules and systems, serving industries such as food, chemical, industrial, water and wastewater, agriculture, and energy.
- The HST segment offers precision fluidics, pumps, sealing solutions, medical devices, optical components, and more, serving markets like food and beverage, life sciences, pharmaceuticals, and aerospace/defense.
- The FSDP segment includes businesses related to fire safety, dispensing, and diverse products.
USD in Million | 2021 | Weight | 2022 | Weight |
---|---|---|---|---|
Health & Science Technologies | 1,119 | 40.5 % | 1,337 | 42.0 % |
Fluid & Metering Technologies | 998 | 36.1 % | 1,166 | 36.7 % |
Fire & Safety/Diversified Products | 648 | 23.4 % | 679 | 21.3 % |
A big part of the company's growth comes from major acquisitions. The company is very aggressive when it comes to adding new capabilities through acquisitions, as we can see in the chart below.
As a result:
- It now operates in all major markets, with significant exposure in the U.S. and Europe.
- It operates in a wide range of markets, including industrial, fire & safety, life sciences, and energy.
- It is the leader in various niche markets.
Thanks to its focus on niches, acquisitions, and margin enhancements, it has grown its sales by 4.6% per year between 2013 and 2022. Adjusted EBITDA has risen by 6.4% per year. Adjusted EPS has accelerated by 8.9% per year.
Free cash flow has grown by 2.8% per year during this period.
The only problem is that the company's focus isn't on dividends.
IEX focuses on four key issues:
- Building a deep moat business
- Benefiting from pricing power
- Growing margins
- Focusing on the return on invested capital
Speaking of capital in light of its dividend, the company's capital spending focus is on organic growth and strategic M&A. The dividend is its third priority.
The company currently pays $0.64 per share per quarter in dividends. This translates to a yield of 1.2%.
Although this may be nothing to write home about (especially for income-focused investors), the stock has a 30% payout ratio and an 8.7% five-year dividend CAGR.
Furthermore, IEX has never cut its dividend!
It also has outperformed the S&P 500 very consistently, as I discussed at the start of this article.
Over the past ten years, IEX shares have returned 234%, including dividends. This beats the performance of the S&P 500 by roughly 24 points. The Industrial Select Sector SPDR ETF ( XLI ) returned 165% during this period.
With that in mind, let's take a closer look at recent events and the stock's valuation.
After all, we want to find out how attractive IEX shares are at current prices.
Recent Events In Light Of Economic Challenges
Currently, IEX shares are roughly 12% below their all-time high, which makes sense as economic headwinds are mounting.
The chart below shows the distance IEX shares are trading below their all-time high (in percentages) compared to the ISM Manufacturing Index, which has been in contraction territory (below 50) every single month this year.
Although the correlation isn't perfect, as we witness when we compare the ISM index to more cyclical companies, we are seeing that the pressure on industrial companies is rising.
This was also visible in the company's 3Q23 results.
During the earnings call, the company acknowledged macro concerns, including higher interest rates and geopolitical risks, and indicated that demand rebounds for pressured HST businesses may extend into 2024.
With that said, in the third quarter, consolidated financial performance saw a decline in orders by 9% and sales by 4%.
Organically, orders were down 11%, with a 6% decrease in sales.
Notably, the Health & Science Technologies segment experienced a 15% organic decrease, while the Fire & Safety Diversified Products segment saw 3% organic growth in revenues.
Furthermore, the gross margin declined to 44.1%, primarily attributed to lower volume leverage and an unfavorable mix.
The adjusted EBITDA margin decreased to 28.4%, down 30 basis points.
Adjusted EBITDA drivers included a 6% organic sales reduction, impacting negatively by $37 million.
Operational productivity and price cost were positive factors, but the mix was unfavorable by $6 million, particularly in the HST segment.
The good news, given the circumstances, is that the full-year 2023 guidance maintained a 1-2% contraction in organic revenue, with GAAP EPS of $7.91 - $7.96 and adjusted EPS of $8.13-$8.18.
Adjusted EBITDA margin is expected to be approximately 27.5%. Capital expenditures are anticipated to be about $80 million, and free cash flow is expected to be 100-plus percent of adjusted net income.
Despite headwinds, IEX maintains a very healthy balance sheet. The company is expected to end this year with roughly $590 million in net debt, which would be less than 0.7x EBITDA. It has an investment-grade BBB credit rating.
This brings me to the valuation part of this article, where I explain why I am waiting for a dip to occur before potentially jumping in.
Valuation
Using the data in the overview below:
- IEX currently trades at a blended P/E ratio of 26.3x.
- The company has a normalized P/E multiple of 22.8x going back two decades.
- This year, EPS is expected to remain flat, followed by 5% growth in 2024 and 8% growth in 2025.
- A return to a 22.8x valuation by incorporation of its dividend and expected EPS would hint at a 0-1% annual total return through 2025, meaning IEX is trading at a fair value.
The current consensus price target is $220, which is 2% above the current price.
While I would be inclined to give the stock a higher valuation multiple, I do not believe that current economic trends warrant a higher multiple.
Although I will give the stock a Buy rating to reflect my long-term view of the company, I would prefer a stock market correction before jumping in.
As I believe the market has become too dovish regarding the Fed's potential interest rate path and inflation, I think we could see a buying opportunity in the coming months.
Takeaway
In the world of industrial giants, the IDEX Corporation stands out as a true wealth compounder, consistently outperforming the S&P 500 with a focus on niches, strategic acquisitions, and margin enhancement.
Operating in diverse markets, including industrial, life sciences, and energy, IEX's growth has been impressive, driven by major acquisitions and a commitment to building a deep moat business.
While its dividend may not be a reason to buy the stock, the company's disciplined approach to capital allocation and consistent financial performance make it a compelling long-term investment.
However, given its valuation, I'm waiting for a dip before potentially jumping in.
For further details see:
IDEX Corporation: A Great Compounder For 2024