2023-10-06 12:16:33 ET
Summary
- IDEX is a well-diversified industrial equipment manufacturer benefiting from industrial 4.0 trends.
- The company's growth is driven by organic expansion and strategic acquisitions in fluid & metering, health & science, and fire & safety technologies.
- Weakness in the Health & Science segment is a short-term setback, but the stock is undervalued, making it an attractive investment prospect.
IDEX ( IEX ) is a well-diversified industrial equipment manufacturer specializing in valves, pumps, Scientific Fluidics & Optics, Sealing Solutions, and Fire & Safety products, among others. The company serves a diverse range of end-markets, benefiting from structural growth trends driven by industrial 4.0. IDEX's growth trajectory has been propelled by internal expansion initiatives as well as strategic tuck-in acquisitions. The company has experienced sluggish order growth since Q3 FY22 , primarily due to weak performance in Health & Science Technologies. Despite this setback, I believe the current market price presents an opportune entry point. In my assessment, the stock is undervalued, making it an attractive investment prospect. Therefore, I assign a "Buy" rating to IDEX.
Both Organic and Inorganic Growth Driven by Industrial 4.0
IDEX's growth has been propelled by a combination of internal organic expansion and strategic tuck-in acquisitions. The company's core focus areas include fluid & metering technology, health & science, as well as fire & safety technologies. This strategic alignment has contributed significantly to their sustained growth and market presence.
These businesses are at the forefront of the industrial 4.0 revolution across all their segments, in my opinion. Firstly, the Fluid & Metering Technologies segment, constituting approximately 38% of the group's sales, distributes critical components such as pumps, small volume provers, flow meters, and injectors. These industrial components play a pivotal role in industrial digitalization, device connectivity, and automation, forming an integral part of the industrial infrastructure.
Secondly, the Health & Science business caters to precision fluidics, medical pumps, precision photonic solutions, and other equipment. The entire medical and life science industry is undergoing digital transformation, and IDEX's products are widely utilized in life science applications, digital printing, and analytical instruments.
Lastly, the Fire & Security business distributes firefighting pumps, valves, controls, and rescue tools. IDEX is currently implementing an integrated system strategy, making their solutions well-suited for the broader industrial industry.
In summary, IDEX's diverse product offerings not only align with the ongoing industrial 4.0 wave but also play a crucial role in the digitalization and advancement of various sectors within the industry.
Diversified End-Markets
For an industrial company, having a well-diversified end-market exposure is crucial as it helps in reducing the cyclical impact on the business. Different end-markets often operate on various cycles, and sometimes these cycles can offset each other. In the case of IDEX, their end-markets span across general industrial, automotive, semiconductor, food & beverage, energy, life science, and other sectors. This diversified portfolio positions them as a robust industrial company.
Certain markets such as life science, food & beverage, and analytical equipment are relatively less cyclical compared to others. However, it's important to note that IDEX is not entirely immune to cyclicality. For instance, during the FY09 period, their organic revenue growth experienced a significant decline of 14%. Despite this challenge, IDEX has strategically managed this cyclicality through a constant acquisition strategy. By continuing to acquire businesses even during recessions, they have been able to balance their overall revenue growth to some extent.
In summary, while IDEX remains exposed to certain cyclical trends, their diversified market presence and proactive acquisition approach have been instrumental in maintaining a resilient business model.
Weakness in Health and Science Technologies
In Q2 FY23 , IDEX experienced a 13% organic year-over-year decline in orders, accompanied by a 6% decrease in revenue within the Health and Science segment. The management attributes these setbacks to inventory destocking across their analytical instrumentation, life sciences, biopharma, and semiconductor markets. They anticipate this weakness to persist throughout the fiscal year.
This decline in demand appears inevitable as the entire life & science industry emerges from the pandemic period, grappling with constrained capital due to a challenging funding environment. I share the view that the end-market demand slowdown is likely to endure. The current tight funding conditions are exerting significant pressure on small and mid-sized life science companies. According to industry experts , the flow of capital in the life science sector is not expected to return to previous levels anytime soon.
Recent Results and Outlook
In Q2 FY23 , IDEX witnessed a 13% organic decline in orders, while their revenue increased by 3% organically. The company has been experiencing sluggish order growth since Q3 FY22 , influenced by two main factors. Firstly, they are transitioning out of the pandemic period and are now facing strong comparisons to the previous year. Secondly, the slowdown in general end-markets is a result of weak macroeconomics.
For the entire fiscal year of 2023, IDEX expects their organic revenue to decline by 1 to 2% compared to the prior year. Specifically, Q3 is anticipated to see a significant decline of 7-8% in revenue organically. In my opinion, their business cycle appears to be reaching its lowest point. Historically, owning an industrial company during a downturn has proven to be a strategic move, based on my past experience.
Their cash flow from operations increased by 26% year over year, attributed to reduced investments in working capital. This trend is typical for industrial companies during economic downturns. They tend to optimize working capital by lowering inventory levels and tightening account payables and receivables. IDEX, following this strategy, successfully removed over $20 million worth of inventories from their business in the quarter.
Moreover, IDEX boasts a robust balance sheet, with a gross debt leverage of only 1.7x in FY22. This financial stability positions them well to navigate challenging economic environments, providing them with flexibility and resilience.
Key Risks
In addition to the challenges posed by Health & Science end-market destocking and weak demands, IDEX has an 8% exposure in the Energy industry. They specialize in selling flow meters, small volume provers, electronic registration, and control products within this sector. Consequently, fluctuations in energy commodity prices could have both positive and negative impacts on their Energy segment. Furthermore, the capital expenditure trends within the broader energy industry can influence IDEX's revenue growth.
However, it's essential to note that IDEX benefits from a well-diversified end-market exposure. While cyclical exposures in sectors like Energy exist, they are counterbalanced by stable markets such as medical and life/science to some extent. This diversification helps mitigate the effects of industry-specific challenges, providing a degree of stability to their overall business performance.
Valuation
In my model, I have assumed a -1% organic revenue growth for FY23, accounting for the impact of Health and Science destocking and sluggish demands. To offset this, I anticipate a 5% growth from acquisitions, a strategy historically contributing 4-5% to IDEX's annual revenue growth. Notably, IDEX is well-positioned to navigate the high inflationary environment. Their management has indicated that pricing increases can more than offset raw material inflation. Consequently, they stand to benefit from this inflationary scenario, leading to an improved operating margin. Based on these insights, I forecast the operating margin to reach 26.1% by FY32. Additionally, the free cash flow margin is expected to reach 23.4% in the same period.
The model incorporates a 10% discount rate, a 4% terminal growth rate, and a 23% tax rate. After discounting all the free cash flows from the firm and adjusting the net debt balances, my estimates indicate a fair value of $230 per share for IDEX's stock price.
Verdict
I am impressed by IDEX's organic and acquisition-driven growth strategies, coupled with their well-diversified end-markets, which mitigate business cyclicality to a significant extent. While the current weakness in the Health & Science end-market might pose short-term financial pressure, I see it as a strategic opportunity for ownership. Considering the undervalued stock price, I confidently assign a 'Buy' rating to IDEX. Their robust growth strategies and diversified market presence make it a promising investment choice.
For further details see:
IDEX: Current Health And Science Segment Weakness Creates A Good Entry Point