Description

Executive Summary

Mettler-Toledo International Inc. is a leading supplier of precision weighing and analytical instruments that service laboratory, industrial, and retail markets. It operates in mostly niche markets, enjoying top 3 market positions across the board and number 1 positions in 75% of markets, including the global lab balance market and the U.S. and European food weighing instruments market. It is a company we have long admired. Key attributes of the business include:

• Leading market positions in niche, mostly fragmented markets stemming from its brand reputation for quality and precision and a huge installed base to drive replacement demand.
• The relatively small addressable markets Mettler competes in act as a natural barrier preventing large, well-capitalized companies from attempting to enter the market. The company lacks a direct competitor company-wide and typically competes against regional companies with more limited capabilities/product sets.
• Its 9,000+ member direct sales force is unmatched in the industry, while its emphasis on data analytics has enabled the company to consistently drive penetration more effectively at new and existing customers.
• The average price of its products is low enough (~$5K) to avoid procurement. Mettler instead sells directly to end users who are more focused on capabilities than price, which has helped the company consistently realize 1-1.5% growth from pricing annually.
• Mettler’s direct sales force informs its product development efforts while it’s scale gives it greater resources to invest in the R&D that ultimately helps drive replacement cycles for its instruments thereby creating a virtuous cycle that supports further market share gains.
• The company has an ingrained culture of operational excellence, continuous improvement, and agility. This company measures every aspect of its business and tries to get a little better every day.

These attributes have been borne out in the numbers. Since 2009, returns on invested capital has averaged 30%, local currency sales have increased 6% annually (mostly organic), earnings per share has increased 15.5% annually, and free cash flow has increased 12.5%. The business has consistently generated more cash flow than it needs and management has deployed >100% of free cash flow into share buybacks since 2004, reducing shares outstanding by almost 4% annually while still maintaining a conservatively levered balance sheet. Looking ahead we see no reason why the company can’t continue generating strong results over time.

So why now? Mettler is almost always an expensive stock but periodically the market can overreact to near-term macro concerns as the company does have an element of cyclicality with technically deferrable instruments accounting for 2/3 of sales. We believe this is one such moment. Currently, investors are worried about continued destocking at its Lab customers and weak demand in China (sales have fallen off a cliff, giong from +LSDs earlier in the year to -25% in 3Q). These are real concerns and they broadly have weighed on the entire Life Science Tools group all year with shares down 20%+ across the board (MTD has seen a greater drawdown (-33% YTD) owing to its outsized exposure to instruments and China), but they are ultimately temporary in nature. At current levels, we think risk/reward is favorable and that we are paying a reasonable multiple for an exceptional business. 

Company Description

Mettler Toledo is a leading manufacturer of precision weighing and analytical instruments that service laboratory, industrial, and retail markets. It is dominant in most of its product categories, with a number 1 market position in ~75% of its end markets.

Despite its dominant market position, it generally operates in fragmented markets where the company is leader in the space with ~25% market share and the remaining competitors consist of small regional players with markedly lower share. Its small markets preclude competition from larger, well-capitalized companies from competing with Mettler.

The business is geographically diversified with ~40% of revenues generated in the Americas, 26% in Europe, and 34% in Asia/ROW. Lab instruments and services, including balances (e.g. scales), pipettes, analytical instruments, software, automated chemistry solutions, and process analytics account for 57% of revenues. Industrial instruments and services, including traditional industrial weighing instrument and terminals plus product inspection equipment used in food processing, packaging, and pharma account for 38% of revenues. And retail weighing solutions (i.e. weighing and food labeling scales used in deli/meat/seafood departments in grocery stores) account for the remaining 5%.

Roughly 2/3 of sales are instrument sales, while consumables/services account for the remaining 33%.

Note these charts are 3-4 years old but directionally relevant

Lab: Sales of lab products and services account for almost 60% of revenue and consist of the everyday products used by scientists and chemists. Mettler supplies ~40% of what is on a Chemist’s workbench, the majority of which are relatively low ticket prices (average price ~$5K) for a product that is required for the worker to do his or her job. Key products include:

• Balances (~20% of overall sales) are the commonly used instrument in the lab, and MTD is the global leader followed by Sartorius in what is a concentrated market with few competitors. This is a GDP+ type business which is mainly replacement driven in the US and Europe while Asia has more growth opportunities as workers move from sharing instruments to individual usage. Replacement cycles average 5-7 years though innovation is needed to drive replacement given low wear and tear.
• Analytical instruments (~10%) include PH meters, density meters, titrators, and thermal analysis. These are high precision instruments that help scientists analyze the materials they are working with. MTD competes against a host of different companies and is taking share. In general, replacement cycles average 5-7 years but this market is growing +MSD to +HSDs due to the strength of its life science customer base.
• Pipettes (~10%) are the 3^rd most used instruments in the lab. These are high margin, consumable products with a replacement cycle of 3-5 years. Mettler (selling under the Rainin brand) is #2 globally behind Eppendorf but is #1 in the US in this market. This market is expected to grow +HSD to +LDD on the back of continued share gains internationally.
• Process Analytics (~10%) is composed of inline sensors that measure and analyze things like conductivity, gas, turbidity, sodium, and oxygen. These are used in manufacturing and generally sold to QA/QC and plant managers. Its largest products in the space are thermal analysis (#2 behind WAT) and titration (#2 behind Metrome) while the entire category is expected to grow +HSD to +LDD on the back of bioproduction strength and share gains.
• Automated Chemistry (~5% of sales) is focused on simulating a manufacturing process inside a lab setting. High amounts of R&D go into this business but larger ASPs of $50-75K/unit help offset the cost. In general this is the most volatile business within the Lab business.

Industrial: Sales of industrial products and services account for ~38% of revenues. These products tend to have lower precision thresholds, which results in a lower margin profile than Lab products. The segment is considered to be more cyclical than the Lab business and is made up of two sub-segments: Core Industrials (~25% of total sales) and Product Inspection (~15%).

• Core industrial product offerings include weighing instruments, industrial terminals, transportation and logistics equipment, vehicle scale systems, and industrial software. Roughly 60% of sales are to the pharma, biopharma, food manufacturing and chemical customers, while the remaining 40% of sales were to customers in the transportation & logistics and vehicle weighing end markets. MTD is the global leader in this segment with ~15% while a division of ITW (Avery & Brecknell) is their strongest competitor with ~10% share. In general this business should grow in-line with GDP.
• Product Inspection offerings include metal detectors as well as x-ray and camera-based systems sold to mid-to-large customers interested in brand protection and Q/A in the food, pharma, and cosmetic industries. Metal Detectors have an average selling price of ~$25K, Check Weighers $10-20K, and X-rays $40-50K. Pricing power is high due to the perceived value to customers of protecting their brand, and demand is less sensitive to GDP. MTD is the global market leader outside of Japan with ~30-35% market share, and its service team in the US is 7x larger than its competitors which helps reduce downtime and increase the speed of service. TMO and ITW has subsidiaries in the space but no competitor can match MTD’s breadth of products. Sales of product inspection equipment and services are expected to grow +LSD to +MSDs in developed markets which are primarily replacement markets while emerging markets are expected to see +HSD to +LDD growth. Margins are essentially at the corporate average in this business.

Food Retail: Food Retail systems account for the remaining revenue (~5%). These products, which include networked scales and software that can integrate info collected from the front and back of stores into an inventory management system, are sold mainly to grocery chains. It also offers automated packaging and labeling equipment for the meat backroom. This is a mature, replacement-driven business with replacement cycles of ~5 years. Unlike other business lines, these sales are to procurement departments and thus are lower margin relative to their other business lines.

Investment Highlights:

1. Attractive markets, a favorable competitive position, and a well-executed sales strategy has delivered consistent growth for decades. Mettler has benefited from attractive, growing markets and a leading market position supported by a brand known for quality and precision as well as its huge installed base. Moreover, Mettler has pressed its advantage by leveraging its 9,000+ direct sales force and the wealth of insights gleaned from its heavy investment into data and analytics to continually increase penetration of new and existing customers.

The company also enjoys strong pricing power as its products are generally sold directly to the end user who cares more about quality than price for instruments that account for a fraction of a companies’ R&D budget but are necessary for the scientists and chemists to do their jobs. As a result, MTD has realized 150-200bps annually on average and expects this level of pricing to be sustainable going forward.

2. MTD’s business mix is slightly less cyclical vs. prior periods. With 2/3 of sales in instruments, there is no escaping cyclicality for Mettler. However, its mix of business has changed for the better in several ways. This won’t prevent sales from declining, as even the Lab business reported 7% organic sales declines in the GFC, but the magnitude of the decline should be somewhat more measured.
   1. Relatively smaller industrial business: In 2009, Industrial end market sales declined 12% organically. At the time, this business accounted for 43% of sales vs. 38% today.
   2. Mix of industrial is better (more Product Inspection and better Core): In 2009, Core Industrial performed far worse than Product Inspection which reported growth in certain quarters (actual numbers were not disclosed back then). In 2009, Core industrial was 30% of sales vs. 13% for product inspection whereas today it is ~25% vs. 15%. Moreover, the mix within core industrials was skewed towards transportation/logistics and vehicle weighing whereas today the business is more focused on food/pharma/chemicals which should be more stable.
   3. Food retail is 1/3 the size: Food retail is Mettler’s most lumpy end market and customers deferred ordering in a big way in 2009, with organic sales declining 15%. This end market was 15% of the business then but is ~5% today.

3. MTD has delivered strong margin expansion for years and we expect more of the same going forward. Since 2000, the company has increased its gross margins and EBITDA margins by 60bps and 70bps annually, respectively. Even at 59% gross margins and 31% EBITA margins we see the potential for as much as 80bps of annual improvement in a 6% growth year, split equally between gross margins and SG&A efficiency.
   1. Gross margins: With 35% of COGs fixed OH, we estimate 6% sales growth leads to ~40bps of margin expansion, assuming fixed cost inflation of ~3%.
   2. SG&A as a % of revenues: Management believes it can leverage initiatives such as Stern Drive (a multi-year project to drive continuous improvement in areas such as back-office, productivity, and material costs with an annual goal of $20mn in savings) and almost 15 year project to standardize its ERP system (nearly complete) to help limit SG&A growth to 2/3 to ¾ of sales growth. Notably, since 2010, SG&A has growth at <60% of the rate of sales.
   3. R&D: Management expects to continue to invest here, so we do not see much room for leverage here.

4. Cash flow to continue to be deployed into buybacks. Mettler is a capital light business with capex averaging less than 3% of sales, and acquisitions have averaged ~$35mn annually since 2000, so the company has opted to return all of its cash to shareholders in the form of buybacks. Since 2004, the company has repurchased $8bn of stock, reducing reduced outstanding shares by ~3.8% annually and 50% cumulatively.
   
   Historically, the company has used over 100% of FCF to repurchase shares, taking its balance sheet from essentially unlevered in 2004 to a still modest 1.6x of leverage as of 2Q23. Going forward, we assume the company maintains this leverage level which would allow the company to repurchase over $2.5bn of stock the next 2.5 years, reducing outstanding shares by ~10% over this time period.
5. Valuation looks reasonable.
   
   

Catalyst

Continued execution