2023-09-27 10:43:10 ET
Summary
- TDY supplies critical technologies for high-tech, high-reliability industrial sectors such as aerospace, defense, and oil and gas drilling. It has maintained profitability and expanded profit margins over the past decade.
- TDY is poised to reignite its M&A strategy as its balance sheet strengthens, potentially adding $340 million in EBITDA in FY25.
- The risk is overpaying in acquisitions, but TDY's history of synergistic acquisitions and operational excellence mitigates this risk.
Summary
This post is to provide my thoughts on Teledyne Technologies (TDY) business and stock. I recommend a buy rating as I believe the TDY balance sheet is on track to reset back to a comfortable level (1.1x FY24 EBITDA based on my estimates), which provides management with sufficient room to conduct another big acquisition. Based on my analysis, TDY could add as much as $340 million worth of EBITDA in FY25, which is ~20% above consensus estimates.
Investment thesis
TDY supplies technologies that pave the way for expansion in high-tech, high-reliability industrial markets. Among these are the aerospace and defense industries, oceanographic studies, deepwater oil and gas drilling, and more. The company sells digital imaging sensors, environmental monitoring and control instrumentation, and ruggedized connectors. In my opinion, TDY is a top-notch business because it has maintained a positive bottom line for the past decade and expanded its profit margins each year. Notably, the strong FCF profile is a direct result of the profitable P&L, increasing from $100+ million in FY12 to a peak of $700 million in FY21 before declining to $400 million in FY22. Recent TDY 2Q revenue of $1.43 billion was up 5.1% year-over-year and bettered the $1.41 billion predicted by consensus. Overall book-to-bill was close to 1x, and adjusted EPS came in at $4.67, which was higher than the $4.64 consensus estimate. The focus of my post is on the M&A strategy of TDY, which I believe is ready to be re-ignited after the last big acquisition of FLIR .
Own calculation
TDY took on substantial debt to finance its largest acquisition to date, FLIR Systems, in 2021. This purchase increased total debt from $916 million to $4.2 billion, and the net debt to EBITDA ratio reached a record high of 4. The TDY leverage ratio had historically been around 1.5x, so this was a significant increase. After two years of ownership, TDY has made significant strides and operational improvements at FLIR. Management's efforts to incorporate the company appear to be paying off, at least in terms of revenue and expenses. With regard to growth, FLIR commercial digital imaging business experienced organic growth in the most recent quarter. Most notably, management noted that the company's defense-related bookings and backlog inflected in 2Q23, with an overall book-to-bill ratio of 1.28x (higher than then group 1x), thanks in large part to the recent $94 million Black Hornet nano-drone orders from the U.S. Army. Cost-wise, the administration disclosed that it would reduce workforce size and incorporate three facilities into the current FLIR footprint. By bringing them together, FLIR should be able to increase its profit margins and TDY will benefit from the synergy.
Now that the FLIR acquisitions "to-do(s)" are off the table and TDY's balance sheet is on track to further improve, I expect management to reignite their M&A engine to find another target to drive growth. As of LTM, TDY has a net debt of $3 billion, which implies ~ 2.3x FY23 EBITDA or ~2x FY24 EBIDTA based on consensus estimates. However, if we take into account the FCF generation capability of TDY, which consensus expects TDY to generate $262 million in 1H23 and ~$1 billion in FY24, a total of ~$1.3 billion, the actual net debt to EBITDA in FY24 is actually ~1.1x EBITDA ($3 billion net debt today minus $1.3 billion of FCF generated over the next 18 months). In order to quantify how accretive the next acquisition may be, I used FLIR as a benchmark (since it is the largest)-FLIR was being acquired for ~18x EBITDA. Assuming TDY increases its leverage to the same 4x, it could raise an additional $3 billion (based on FY24 EBITDA), which translates to the possibility of adding $340 million in EBITDA (~22% of FY24 consensus EBITDA).
Own calculation
That said, I agree that it is hard to time the next acquisition, and TDY could spread acquisitions across various targets. Nonetheless, my analysis shows the potential for it. Remember that TDY is a serial acquirer, and M&A is one of its core strategies. Since 2014, TDY has made nearly 40 acquisitions. This acquisition model, along with TDY management's solid execution, has created substantial shareholder value and is a large driving force behind the company's reliable earnings and free cash flow growth over the years.
Valuation
Own calculation
My model is to show the potential upside if TDY were to make another large acquisition, which I believe management will do as it is part of their core strategy. I believe the fair value for TDY based on my model is $478. My model assumptions are that EBITDA will continue to grow as per consensus estimates (I have no variant view here) and that TDY will make a large acquisition again that will drive further growth in EBITDA. TDY should continue to trade at the same valuation vs. peers as it has been over the past few years, at 15x forward EBITDA.
Risk
As to all M&A strategies, the main risk is overpaying. However, I believe TDY has shown through its operating history that it is able to reap synergies from its acquired targets and not overpay. This is apparent in its FCF growth over the years.
Conclusion
I maintain a buy recommendation for TDY. The company's robust financial position and successful integration of FLIR Systems suggest that its M&A engine is poised for a resurgence. With the balance sheet on track to improve, TDY has the potential to add approximately $340 million in EBITDA in FY25, enhancing its growth prospects. While timing acquisitions may pose a challenge, TDY's history of disciplined acquisitions and operational excellence usually bodes well for shareholder value creation. My model indicates a fair value of $478, assuming TDY continues to grow EBITDA in line with consensus estimates and executes another significant acquisition. The primary risk lies in overpaying for acquisitions, but TDY's track record of realizing synergies mitigates this concern in my view.
For further details see:
Teledyne Technologies: M&A Engine To Reignite As Balance Sheet Strength Returns