2023-11-16 02:38:54 ET
Summary
- Novanta has experienced significant growth and diversification over the past decade, with a focus on advanced industrial and medical applications.
- The company's valuations have been high, but recent performance has been tougher, leading to a sell-off in shares.
- Novanta recently announced an acquisition of Motion Solutions, which could contribute to future growth, but near-term earnings accretion likely will be limited.
Shares of Novanta ( NOVT ) have seen a huge and successful transition over the past decade, delivering on handsome returns for investors in the process. The company has built up interesting niche positions in secular long-term growth markets, although this has been more than recognized by the market, which has awarded shares ever higher multiples in recent years.
These valuations are quite demanding as Novanta has seen a tougher 2023 so far, albeit it announced an interesting deal, warranting a continued review of the business.
About Novanta
Novanta describes itself as a sole-sourced technology partner to global OEMs. The company is split pretty evenly between application areas in advanced industrial settings as well as medical applications.
Within the advanced industrial market, the company focuses on robotics, automation, precision manufacturing, and EV production. Within the medical domain, expertise is seen in minimally-invasive surgery, surgical robots, precision medicine, and ophthalmology.
By focusing on these engineered segments and innovation, the company sees strong growth in an asset-light business model. The company is not just talking the talk but also walking it, as Novanta has grown from a quarter of a billion revenue base a decade ago to $860 million by now, as rapid growth has gone hand in hand with diversification, with the medical segment largely non-existing yet a decade ago.
This is driven by organic growth as well as nearly 20 deals being announced at a combined cost of around a billion, adding substantially on top of the organic growth profile as well.
This growth has been recognized by investors as well. Novanta was just a $10 stock in the year 2012 and traded in its teens through 2016 after which strong momentum propelled shares to a high near the $100 mark pre-pandemic. Shares rallied to the $180s late in 2021 and over the past summer, but shares have sold off quite a bit in recent months, now trading at $135 per share.
What Are These Expectations?
In March of this year, Novanta reported its 2022 results, a year in which revenues rose by 22% to $861 million. GAAP operating profits rose to $103 million, as net profits came in at $74 million, equal to $2.06 per share. Adjusted earnings came in a dollar per share higher, at $3.07 per share to be more precise, with most of these adjustments due to amortization charges, making the adjusted numbers quite realistic.
The company guided for modest growth in 2023, with revenues seen at $890-$915 million, although adjusted earnings were seen rather flattish at $3.00-$3.20 per share. Net debt of $335 million was very manageable given the growth as adjusted EBITDA of $184 million translated into a leverage ratio of around 1.8 times. Needless to say, with shares trading in the $150s in March, valuations were rather demanding at roughly 50 times adjusted earnings.
In May, Novanta posted a 7% increase in first quarter sales to $219 million, albeit that higher interest rates made that adjusted earnings rose by just a penny to $0.74 per share. Second quarter sales rose a similar 7% to $229 million, with adjusted earnings up 2 pennies to $0.80 per share.
Third quarter results, as released early in November, were not so pretty and triggered a sell-off towards the $120 mark. Third quarter revenues of $222 million were actually down nearly a percent compared to last year, albeit that margins were quite good with adjusted earnings up four cents to $0.85 per share.
The company attributes the lack of growth to higher interest rates resulting in delayed capital expenditure decisions made by customers. This results in a book-to-bill ratio coming in quite a bit below 1 time, yet the backlog of over half a billion remains very substantial.
Fourth quarter sales are seen between $208 million and $212 million, down from a $218 million number in the final quarter of 2022, but moreover, adjusted earnings are seen down to just $0.59-$0.66 per share. All this should result in full-year sales of around $880 million and adjusted earnings closer to $3.00 per share, both of which fall short compared to the original outlook for the year, although the company touts solid prospects for 2024 and beyond. Net debt has already come down to $277 million and with EBITDA seen around $195 million, leverage is no issue.
With 36 million shares trading at $120, the market value of the firm fell to $4.3 billion, as a $4.5 billion enterprise valuation came in around 5 times sales and a more reasonable, but still demanding 40 times earnings multiple.
And Now?
Since the release of the weak third quarter results little over a week ago, shares have recovered to the $135 mark and the immediate reason appears to be the acquisition announcement of Motion Solutions. The company has reached a $189 million deal to acquire this engineering partner in medical, life science, and advanced industrial applications business. The Irvine-based business employs 110 workers and will contribute $85 million in sales, as the resulting 2.3 times sales multiple comes at a steep discount to Novanta's own valuation.
The deal presentation reveals that a 12 times EBITDA multiple has been paid, revealing an EBITDA contribution of about $16 million, for margins near 20%. That suggests that the business is about equally profitable as the company itself, making the purchase price look quite cheap indeed.
That suggests that a near $200 million deal tag and valuations are actually worth a lot more, but of course, it has been a $10 jump higher in the share price, which priced in these prospects already. The downside is that near-term earnings accretion is likely limited as the company indicated that debt costs will run at >6% here.
Pro forma net debt will jump to $470 million, still very manageable with pro forma EBITDA seen around $210 million, for a leverage ratio of around 2.3 times, very manageable.
What Now?
The reality is that I am deeply impressed with the turnaround and growth story for Novanta, as well as the latest bolt-on deal. The issue is that expectations have run quite high, despite the setback of the share price in recent months, as valuations had simply been carried away too much in the past.
Given this, I see no reason to get involved with the shares at this point in time, but the deal and business certainly deserve a position on my watch list as I would be keen to provide updates on Novanta from here onwards.
For further details see:
Novanta: An Interesting But Expensive Hidden Gem