Summary
- IDEX beat top-line expectations for Q4'22, but margins were softer than expected and initial guidance for 2023 was cautious with management talking about a "period of transition" in 2023.
- Industrial demand is slowing, as is demand from semiconductor and chemical customers, and destocking among life sciences customers is a headwind.
- Longer term, there's nothing amiss here, and IDEX remains leveraged to many secular growth opportunities like precision ag, gene sequencing, and semiconductor capacity growth.
- IDEX shares are trading around the middle of the range for compounders, and is worth monitoring if this post-earnings reaction turns into a bigger downward move.
High multiples usually mean high expectations, and between outperforming the broader industrial space, including fellow “compounders” like AMETEK ( AME ), Danaher ( DHR ), Nordson ( NDSN ), Roper ( ROP ) and Rockwell ( ROK ), and carrying a high forward EBITDA multiple, I believe IDEX ( IEX ) qualifies. With fourth quarter results coming in a little mixed and a more cautious tone from management on near-term operating conditions, some of that premium valuation is unwinding a bit.
It’s no exaggeration to say that there’s just so much uncertainty right now about how 2023 is going to develop, with even those companies reporting better-than-expected results for the fourth quarter warning that they still lack insight into 2023 demand trends. I have no concerns about IDEX from a longer-term perspective (apart from the sustainability of the multiple), but if investors start taking a more negative view of IDEX’s cyclical sensitivity and sell these shares down closer to $00 or so, it’s definitely a name I’d consider strongly.
Challenges Emerge In The Fourth Quarter
IDEX still did beat sell-side expectations for the fourth quarter, so for as negative as this write-up may sound, that’s worth emphasizing. Revenue was about 5% better than expected, but margins did come in weaker than expected, as did cash flow, and guidance for 2023 was weaker than expected.
Revenue rose 12% in organic terms, which in this still-early phase of the reporting cycle is looking like an average to modestly above-average result. The Fluid & Metering Technologies (or FMT) segment posted 9% organic year-over-year growth, but a nearly 7% sequential decline and sales appeared to be a little light of expectations. Health & Science Technologies (or HST) remained strong, growing 19% organically (and 2% qoq reported), beating by a sizable margin. The Fire & Safety / Diversified Products business (or FSDP) posted 6% organic yoy growth (and a slight sequential decline), and was in line with expectations.
Gross margin declined 40bp yoy and 150bp qoq (to 43.6%) on an adjusted basis. Adjusted EBITDA rose more than 26%, with margin up 10bp to 27.0%, while operating income rose about 9% (margin down 100bp to 21.8%), coming up about 4% short of expectations.
Overall segment profit rose about 14%, with margin steady at 25.6%. Looking at the segments, FMT saw 21% profit growth, with margin up 150bp yoy (but down 400bp qoq) to 26.7%. HST profits rose 16%, with margin down 90bp yoy to 24.9%, and FSDP profits fell slightly, with margin down 40bp to 25.2%.
Orders increased 1% in organic terms and 3% qoq in reported terms, with FDSP driving the growth. FMT orders rose 7% yoy organic and fell 5% qoq reported, while HST orders fell 8% yoy organic and about 1% qoq reported. FDSP orders rose 9% yoy and 26% qoq.
“Transition” Is The Call For 2023
Management characterized 2023 as a “year of transition” and put out initial guidance of 1% to 5% organic revenue growth that at the midpoint is about 2% below expectations heading into the quarter. Management did indicate that the first quarter will be stronger, with 3% to 5% growth, but that is also below prior expectations (by about 3%).
Within the FMT business, I wasn’t surprised to see management characterize markets like agriculture and water as healthy. This is consistent with my expectations for the year, and I continue to believe that precision agriculture is a meaningful driver not only for ag equipment companies like Deere ( DE ), but “behind the scenes” players like IDEX as well.
The characterization of energy as “stable” was modestly disappointing compared to my expectations, while more neutral commentary on industrial markets was as I expected. Weaker trends among chemical customers also surprised me some, given commentary from companies like Dover ( DOV ) and Rockwell and the longer timeline for debottlenecking projects.
Looking at HST, slowing semiconductor demand is not a surprise, but management believes they can offset a weaker market with share gains and I expect capex weakness to be short-lived given the fab expansion plans across the industry. Life sciences remains healthy, particularly next-gen sequencing, but it looks like there will be headwinds from inventory destocking (something Dover also mentioned).
In FSDP, I’m a little surprised by weak dispensing, but strong fire/rescue, auto, and aero aren’t surprising.
Stepping back a bit, IDEX does have notable “industrial” exposure at around 15% or so of sales, and that’s likely to weaken into the fall of this year. I’d have thought energy (5%-10%) would hold up better, and likewise with chemical processing (about 5%), while water (around 5%-10%), agriculture (5%), and auto (around 5%) should be healthy. I don’t think life sciences destocking will be a long-lived phenomenon, and I expect strong growth long-term for sequencing and analytical instrumentation.
The Outlook
I don’t think there’s anything in the numbers or outlook to be overly concerned about – IDEX is still best-of-breed in fluid management, especially precision fluidics, but it’s not immune to macro pressures. It’s also worth noting that historically IDEX has never been too far removed from underlying economic activity (as measured by industrial production).
While my near-term estimates are now lower, my longer-term estimates (five and 10 years out) haven’t changed much, and I’m still looking for strong long-term revenue growth in the neighborhood of 6%. Opportunities in semiconductors, life sciences, precision ag, photonics can all support differentiated growth, and I expect ongoing long-term improvement in margins and returns (ROIC, et al). At the cash flow line, I expect cash flows to ramp up to over 20% of revenue over the next two or three years, and then expand into the low-20%s, driving low double-digit compound FCF growth.
IDEX is not conventionally cheap, and it seldom is. The shares are now trading at a little more than 20x my 2023 EBITDA estimate, and while compounders like IDEX have traded at forward EBITDA multiples ranging from 16x to 24x, the group as a whole has retreated back to the lower edge of the range.
The Bottom Line
I can appreciate IDEX as one of those relatively rare “just ignore the valuation and buy it” types of stocks, but that’s just not how I approach investing. That said, if this post-earnings reaction stretches into a more significant sell-off or period of underperformance, particularly if it takes the shares below $200 without a substantial change to the long-term outlook, I would enthusiastically revisit this name.
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Watch IDEX For A Window Of Opportunity