Summary
- Near-term headwinds are starting to fade, and I think investors are now pricing in the future years of FY24/25, resulting in a strong rally and multiples reversion.
- The focus remains on EMVs, and VNT continues to project a $300 million headwind for the year.
- VNT's 4Q22 was in line with expectations, despite a sales beat that was partially offset by lower margins.
- For FY23, VNT has set its adjusted EPS guidance at $2.73 to $2.83, which seems conservative given the company's strong momentum and the generally optimistic state of the demand environment across most end markets.
Description
As we start to look past Vontier Corp.'s ( VNT ) weak near-term headwinds, I believe investors are incrementally pricing in FY24/25, as can be seen in the strong rally and multiples reversion to mean. As such, I think the key obstacle identified in my post , the stock narrative is turning for the better. While I have missed the big rally, I think there is still a small upside of 14% left.
4Q22 results review
Overall, I believe that VNT's 4Q22 was in line, despite a sales beat that was partially offset by lower margins, and the 2023 outlook was also generally in line with expectations. The focus remains on EMVs, and VNT continues to project a $300 million headwind for the year, $40-$50 million of which will be realized in 1Q23, with the remainder of the headwind increasing sequentially and making up about 65% of the full year in 2H.
Despite this, the good news is that quarterly order growth was 10% year over year, suggesting that demand is holding steady. Furthermore, VNT stock has a book-to-bill ratio that is slightly above 1x, indicating that new orders are coming in at a healthy pace. The backlog, which refers to the volume of orders that are waiting to be fulfilled, is also higher than pre-pandemic levels, and the company was able to fulfill orders faster than anticipated due to improvements in the supply chain. All of these factors combined resulted in sales that exceeded expectations. Also, something to note is during the quarter, the significance of volume was greater than price (excluding EMVs). Prices remained around the mid-single-digit range, suggesting a volume increase of 4-5%.
Forecasts for FY23 sales, excluding EMVs, are in the mid-single digits, with Matco and DRB both contributing to this growth in their own ways. Price increases in the low single digits should make it possible for VNT to meet its guidance range with modest increases in core volumes in 1H23. Overall, this quarter's top-line results were reassuring and helped calm fears about the company's fundamentals.
However, in my opinion, VNT can only "hide" under the EMV headwind headline for so long before it must begin demonstrating that the underlying business is going strong. This is because although the company's top line exceeded expectations, the resulting profit was not as high as expected. After accounting for factors such as EMVs, currency, acquisitions, and other one-time events, the core incremental margins were only between 5-10%.
Capital allocation
This year, VNT hopes to reduce its debt by $150 million to $200 million. Management has stated that any cash remaining after debt repayment will be allocated to either share repurchases or M&A, with a recent trend toward the former. While this is not in my model or expectations, capital allocations to help boost earnings growth or EPS figure, which could aid in beating guidance.
Guidance
For FY23, VNT has set its adjusted EPS guidance at $2.73 to $2.83, which, despite the fact that the impact of EMV headwinds has not changed, seems conservative to me given the company's strong momentum and the generally optimistic state of the demand environment across most end markets. The 2023 guidance takes into account the expected contribution for the entire year from Hennessy & GTT, which VNT's management has indicated that they plan to sell. The guidance also do not take into account any further share repurchases. With the introduction of new pricing measures in January and the possibility of further measures if the inflationary environment persists, management anticipates a low-single-digit increase in pricing throughout 2023.
Valuation
My initial model predicted a share price of $19.72, which proved incorrect because I underestimated how quickly the market would begin to price in FY24/25 (post EMV headwinds). This is evidenced by the recent strong multiples reversion from 7x to 9x. Given the strong rally, I believe there is much less room for multiples to imply a revert (historical average is 10x). That said, looking at VNT from a market standpoint (valuing at FY25), I believe there is still 14% upside even if multiples remain at current levels.
Own estimates
Summary
In conclusion, the near-term headwinds for VNT are starting to fade, and investors are now pricing in the future years of FY24/25, resulting in a strong rally and multiples reversion to the mean. The focus remains on EMVs, and VNT continues to project a $300 million headwind for the year. However, the good news is that quarterly order growth was 10% y/y, and the backlog is higher than pre-pandemic levels, indicating a healthy pace of new orders. All in all, the stock narrative is turning better and investors are giving the benefit of doubt that VNT can get past near-term headwinds. That said, if VNT fails to show improvement in underlying profits, the stock might get impacted.
For further details see:
Vontier Corp.: Narrative Around The Stock Seems To Be Turning For The Better