2023-11-06 12:46:01 ET
Summary
- IDEX reported -11% organic order growth and -6% organic revenue growth in Q3 FY23.
- The Health & Science Technologies segment declined by 15% in organic revenue, driven by weak demand and destocking challenges.
- The management expects a recovery in FY24 and I lowered the fair value to $220 but maintained a 'Buy' rating.
IDEX ( IEX ) reported its Q3 FY23 results on October 25th, 2023, revealing -11% organic order growth and -6% organic revenue growth. As discussed in my introductory article , their Health & Science Technologies segment is experiencing weak demand and destocking challenges, causing the segment to decline by 15% in organic revenue in Q3. The management expects a recovery in FY24. I lowered the fair value to $220 and maintained a 'Buy' rating.
Q3 FY23 Review and Outlook
Orders declined by 11%, and organic revenue was down 6% this quarter. The major driver for this growth weakness was the Health & Science Technologies segment, which declined by 15% year over year. This segment represents more than 40% of total revenue, explaining the group-level sluggish growth for this quarter.
The management explained the weakness of Health & Science Technologies during the earnings call , highlighting the pressure from the life science, analytical instrumentation, and semiconductor markets. Specifically, the analytical instrumentation business continues to experience customer destocking due to weak Chinese demand and lower pharma and biopharma spending, as stated by the management. They anticipate that market demand will remain similar in the next quarter and start to improve from FY24. I find the weakness of Health & Science Technologies understandable in the current macro environment, and most importantly, I agree with their management that they are currently at the bottom of the cycle.
Pharma and biopharma, both end-markets, represent about half of the total Health & Science Technologies revenue. I believe the entire pharma and biopharma industry is currently facing challenges in capital funding, especially for small-sized pharma and biopharma companies. On one hand, the high-interest rate environment makes capital funding costly and reduces the capital return on investments. On the other hand, many pharma and biopharma companies experienced extra growth from Covid during the pandemic, and now these companies are gradually losing this Covid-related growth.
In the Soft Semiconductor sector, which accounts for 8% of Health & Science Technologies revenue, IDEX optical technologies serve semiconductor metrology and provide components for lithography. IDEX also has exposure in the memory market, as hinted by their management. Gartner has forecasted a global semiconductor market decline of 11% in 2023, and the memory market is grappling with overcapacity and excess inventory. Additionally, the PC, tablet, and smartphone semiconductor markets are experiencing weak demand.
I believe some of the weakness is driven by the overall economy and high-interest rates, while some are caused by the cyclical nature of end-market demands, such as memory and personal electronics.
In terms of cash flow, they generated $227 million in cash from operations, marking a 14% increase year-over-year, driven by inventory reduction. They disclosed that they eliminated $25 million worth of inventory from their business in Q3. Consequently, their free cash flow increased by 14% year over year.
Regarding the FY23 guidance, they maintained the organic revenue guidance of -2% to -1%. At the midpoint, they raised their EPS guidance, thanks to a lower quarterly effective tax rate. Overall, there is no meaningful change in the guidance, and I believe the weak growth in their Health & Science Technologies for FY23 has already been accounted for in the guidance.
Fluid & Metering Technology
Fluid & Metering Technology accounts for 38% of the group's revenue. This quarter, orders decreased by 5%, and revenue declined by 1% organically. The overall industrial softness aligns with expectations. According to the Institute for Supply Management , the manufacturing sector contracted in October for the 12th consecutive month, with the PMI standing at 46.7%. Therefore, the overall industrial weakness is inevitable, and IDEX cannot be immune.
In addition, their management also indicated challenges in destocking agricultural products, exacerbated by declining net farm income and crop prices. Agriculture accounts for 11% of Fluid & Metering Technology revenue. As illustrated in the chart below provided by Trading Economics, wheat prices have started to drop since mid-2022.
Therefore, the drop in crop prices would adversely affect farmers' capital spending, in my view. IDEX sells electric valves and controllers, severe-duty pumps, fittings, and systems used in liquid handling to the agricultural end-market. The weak end-market demands could pose challenges for IDEX's Fluid & Metering Technology segment in the near-term.
Valuation Updates
I assume a -1% organic revenue growth for FY23, with acquisitions contributing 5% to topline growth. These assumptions align with the management's guidance for the full year. I continue to assume that IDEX will generate 7% normalized organic revenue growth and 5% acquisition growth. Similar to the assumptions used in my previous DCF, I anticipate a recovery in FY24 with 10% organic revenue growth and 5% acquisition growth.
The fair value of their stock price is estimated to be $220 in my model, using a 10% discount rate, 4% terminal growth rate, and a 23% tax rate.
Conclusions
IDEX is facing strong headwinds from the pharma, biotech, semiconductor, and agriculture end-markets, and I believe they have reached the bottom of the end-market cycle. In my opinion, for cyclical companies, the best time to own them is during the bottom of the cycle. I maintain a 'Buy' rating and lower their fair value to $220 per share.
For further details see:
IDEX: Recovery Into FY24, Except Health & Science Technologies; Maintain 'Buy'