Clay Bruning
145 posts
@cbruning2
Views expressed are my own. Not investment advice.
Veralto $VLTO reported this morning – great print, solid conference call, stock up ~7%. Veralto spun out of Danaher $DHR in late September / early October 2023 – I visited with management in Waltham, MA later in Q4 and started building a position. Veralto has joined Ecolab $ECL in my portfolio as another high-quality industrial compounder, with defensive growth characteristics. I enjoy writing about great businesses, and this is a great business. For those unfamiliar, Veralto is comprised of Danaher’s water quality assets (~60% of sales) and their product quality and innovation assets (~40% of sales). Water quality consists of both treatment and analytics and serves industrial, municipal, and other end markets like hospitals. Product quality and innovation consists of marking / coding and packaging / coloring and serves CPG and pharmaceutical end markets. I like the water quality business better (secular trend, steadier end markets, growing faster, more predictable, etc.), but product quality and innovation is higher margin and generates meaningful cash flow. This is a global business with 3 primary geographies: North America ~50%, Western Europe ~25% and high growth markets (APAC & LATAM) ~25%. Veralto delivers mission critical products / services that help solve important customer problems – for context, ~85% of sales are related to water, food, and essential goods (like pharmaceuticals). These are not elective areas of spend for customers, which gives the business defensive characteristics. Many industries are under pressure to achieve sustainability targets and Veralto is positioned with solutions to help them. Importantly, Veralto is largely levered to their customers’ opex (vs. capex, which can be lumpier) for processes where cost of failure is high – this helps them get deeply embedded in their customers workflows, improving their position relative to competitors. Revenue streams are predictable and recurring given ~60% of sales are consumables – this is the razor / razor blade model. Consistent margin expansion (~50% incremental margins in Q2), which is a result of operating leverage and greater focus deploying VES (Veralto enterprise system), which is their version of DBS (Danaher business system). Impressive free cash flow generation, with minimal capex requirements and >100% free cash flow conversion. Historically, these businesses would generate substantial cash and that cash would go back to the parent company (Danaher) to be deployed into life sciences and diagnostics end markets. Now, that cash can be redeployed into M&A and other areas for the benefit of Veralto, further solidifying their competitive position. Discipline M&A is a capital allocation priority and an important part of the thesis. Danaher has a history of buying the right company, in the right market, at the right price. They should continue to redeploy capital into high ROI opportunities at Veralto. And ~1.3x net leverage gives them the financial flexibility to do so. Over time, I see this as a mid-single-digit organic grower, that should be able to grow earnings double-digits (inclusive of M&A, which is obviously not included in street estimates). As you’d expect with a business like this, management quality is high. CEO Jennifer Honeycutt has spent her career leading various companies within Danaher – she’s an excellent leader and a wonderful person. Jennifer was hired by legendary Danaher CEO Tom Joyce, who is both a friend and a mentor to me. Given all these attractive characteristics, it makes sense that the stock would trade at a premium valuation (~20x EBITDA vs. Danaher ~25x). I initially paid a mid-high teens multiple for this stock, but am comfortable holding the stock as the multiple expands given my high degree of confidence in future cash flows and managements ability to execute. This is a name you buy or add to on a pullback, particularly if you believe we are late cycle. Markets loves certainty, and when macro circumstances become less certain, Veralto will be a relative winner. A few more notes from the Q2 report… General commentary: Better than expected positive volumes and pricing in line with historical levels (~2%). China has stabilized, but don’t expect a meaningful recovery this year. Funding is still tight at state owned and state sponsored municipalities (which are massively over-levered). Raised guidance reflects incrementally more positive view of end markets. PFAS – incredibly difficult and complex problem to solve, but Veralto is well positioned given their history. Still a few years away. Water Quality: Core growth +4%, with 24.7% operating margin, up 70bps y/y. Strong demand growth from industrial segments and steady demand growth from municipalities. Water treatment solutions grew high-single-digits in North America, benefiting from demand at semiconductor fabs and data centers. Called out the CHIPS act and the extensive amount of water used in cooling. Also elevated demand for UV treatment at municipalities. Many municipalities are executing on project backlog to improve (outdated) plants. Product Quality & Innovation: Core growth +3.4%, with 27.6% operating margin, up 100bps y/y. CPG sentiment is improving. Consumables grew mid-single digits for the 4th consecutive quarter. Consumables typically lead equipment sales, which is an encouraging sign for the back half. Margins: Benefited from consumables mix and growing software / subscription revenue in packaging / coloring. Should see run rate corporate costs (from being a new public company) in the back half.
MarketAxess: Buy The Dip On This Compounder? MarketAxess is a leading player in electronic bond trading, and its stock is off 63% from all-time highs - Total credit trading volume has grown at an 18% rate since 2014 - Expanding quickly into Europe, with a foothold in Asia - Operating income growing 11.5% per year since 2014, but stagnated in recent years The stock now trades at a forward EV/EBIT of 23 Is now the time to buy $MKTX?
What are the best small $POOL, $WSC, $CSU type rollups that have a long runway, a well defined M&A strategy, and an excellent management team?
