Description

Thesis Summary

•          Vontier is a recent (10/9/2020) spin from Fortive (FTV) that is currently digesting a churn of their shareholder base which is causing the stock to trade at a very attractive level. Fortive shareholders are growth or GARP while VNT falls into the “value bucket” thus creating this unique opportunity.

•          Industrial capital goods stocks are trading at an average of 24x 2021 P/E (Min 11.6x, Max 62.3x) and 24.6x FCF (Min 10.9x, Max 59.3x). VNT is currently trading at the lowest P/E Multiple (11.1x) and FCF Multiple (10.5x) within the group.

•          The company has 43% Gross margins (vs. group average of 39%), EBITDA margins of 23.5% (vs. group average of 20.5%) and has been significantly less cyclical throughout prior cycle.

•          We believe the current discount is unwarranted and is attributable to selling pressure from FTV shareholders and misperceptions regarding future prospects for the business. Our near-term PT for the business is $41

Description

Vontier consists of 5 different companies:

1.  Gilbarco Veeder Root (1.9bn 2019 sales / 69% of total) – Global leader in retail fueling (gas stations) equipment and services. Products include fuel dispensers, point-of-sale software, payment systems, cloud services, tank monitoring systems, aftermarket services, and EV chargers.
2. Matco ($500m 2019 Sales / 18% of Total) – Manufacturer and distributor of vehicle repair tools, toolboxes, and automotive diagnostic equipment and software through a network of >1,800 franchisees across North America
3. TeletracNavman ($190m 2019 sales / 6.9% of total) – Global SAAS telematics provider. Solutions include fleet management, equipment utilization tracking, electronic logging devices, and vehicle tracking which increase safety and efficiency.  60% of its customers are service providers (i.e Pizza delivery), 30% highway freight and 10% construction and mining.
4. Hennessy ($130m 2019 sales / 4.7% of total) – Manufacturer of aftermarket wheel-service equipment
5. GTT ($40m 2019 sales / 1.4% of total) – Provider of intelligent traffic control systems

Thesis

1. Technical pressure

•         Industrial investors consider Fortive a “compounder”. It grows sales organically faster than the average company, generates strong FCF, and deploys that FCF into acquisitions. The company is also a best-in-class operator and has high gross and operating margins which enables a fly-wheel of value creation. Fortive’s predecessor, Danaher, has been one of the best industrial performers in the past several decades utilizing this strategy. Therefore, the separation of Vontier, which is levered at 3.0x (thus limiting the M&A upside in the next year or so), and concerns regarding its ability to grow over a longer period of time, is creating an investor mis-match. Fortive’s traditional shareholder that has a growth tilt is selling this spin and creating shareholder pressure.

•         Further, Fortive currently owns 33.5m shares of Vontier which they intend to sell in the next 12 months. This can be seen as a further overhang on the stock but we believe it is transitory and Fortive will be thoughtful about when and how they dispose the shares.

•        Since the separation ~63m of 134.5m floated shares have traded. The stock has drifted from a when-issued value of ~$35 to a current value of $28.25 with a trough of $26.36. Estimates are that somewhere between 50-70m shares will need to change hands for the stock to stabilize. We are in the final stretch and most likely selling pressure will ease in the upcoming week. This will serve as a catalyst for shares to drift towards near term fair value which we believe to be $41.

2. Danaher Legacy - best in class assets

•         Most of the assets in the Vontier portfolio are legacy Danaher assets (GTT was the only one acquired by Fortive) and have been under Danaher’s control for decades before they were spun to Fortive and now to Vontier. Matco was acquired in 1981, Gilbarco in 2001, and Veeder-Root in the early 80s.  This is important because of the Danaher culture and operational excellence - what they refer to as the Danaher Business System (DBS). Continuous improvement, measurement, and drive to succeed is innate in Vontier culture (perhaps even more than the current Danaher ones as these assets precede most of the current Danaher assets). We believe this is a key ingredient for the future of this company and a very fertile ground for further acquisitions.

3.  Future of Vontier

•         Just like Danaher and Fortive, Vontier is going to use its strong FCF generation for acquisitions, mimicking the flywheel of its predecessors. The company committed to spend $1.5bn on M&A in the next 2-3 years vs. current market cap of $4.8bn (~ 30%). It will continue to deploy the core principals of the Danaher Business System with its own Vontier Business System.

•         GVR – After the digesting the overhang of the EMV regulation (more on that in the next section). GVR will focus on growth in emerging markets where gas stations are significantly underpenetrated.  For example, India is currently doubling its gas station count and GVR is the largest player in India. The company expects this business to continue to grow at MSD levels going forward (post EMV digestion) with LSD growth in DM and HSD-DD in EM.

•           Matco – Matco’s growth is mainly a function of expansion or growth in franchisee count. Matco’s end market grows LSD but with franchisee growth of ~2.5% per year the company expects growth to be close to MSD. Over 30% of the regions in NA still do not have any Matco franchisees so there is significant room for growth vs. competitors such as Snap-On that are fully penetrated and just grow with the market.

•           TeletracNavman – The company had several challenges and operational mishaps in recent years but with their new TN360 platform that applies AI solutions to the telematics platform the company is expecting to return to growth and continue compounding at HSD organic growth rates. The SAAS model should continue to expand the high margin recurring revenue stream.

 4.  The Overhangs

1.       EMV – EMV is short for Europay Mastercard and Visa. It refers to the change in regulation the requires credit card transactions to be conducted via a chip that is located on the cards vs. the magnetic stripe. This regulation has been around for several years in the consumer and retail space but has not been fully implemented in gas retailers in the US. The regulation was supposed to be implemented in 2016 but was postponed to 2020 and due to Covid was postponed again to 2021. Once the regulation is implemented, if a gas station does not support EMV it will be liable for any fraudulent transaction. Under normal circumstances, the credit card provider incurs the liability. GVR sells equipment to gas stations to comply with the regulations. Retailers can buy new compliant dispensers (which are costly and can cost between $10-15k per dispenser) or an upgrade payment kit (which costs $3k).

These are the facts we know about the EMV rollout:

a.       Retailers have been purchasing EMV compliant equipment since 2014

b.      By the end of 2019 – 55% of US gas pumps were EMV compliant

c.       In 2019 GVR’s relevant US business accounted for ~$600m out of total GVR sales of $1.9bn

d.      Vontier currently assumes that by the end of 2020 70%+ of US gas pumps will be compliant

e.      They are also assuming that 2020 will be the peak year for EMV sales and expect sales declines of $150-200m in 2021 due to the “EMV cliff”

f.        Vontier claims that since 2014 EMV has provided an additional 1% CAGR to GVR’s growth

g.     Last year, during the CS industrials conference, FTV’s CFO gave estimates and projections regarding the EMV cycle and. At the time, he sized the business at $600-700m and projected 2020 to be peak year for the EMV business with 2021 sales falling by $50m 2022 sales by $100m and $2023 by $50m (for a total of $200m).  Today, VNT’s management is sizing the business at $600m and calling for $175m drop instantaneously in one year.

 There is significant uncertainty regarding the adoption curve going forward. Technician availability, access to sites (due to covid) and willingness to upgrade (some might want to bear the liability) are the main variables to consider. Vontier management admits they have no visibility into next year. Their guidance for next year seems punitive and is meant to set a low bar so the company can build a track record of beating estimates.

The normal replacement cycle of a dispenser is ~10 years. Given that a significant of the EMV upgrades have been to payment kits (~40%) we assume a continuation of a normal replacement cycle in the US starting in the 2H of 2023. In the meantime, GVR’s organic growth is expected to be flattish (starting in 2H 2021) with organic growth in EM offsetting DM headwinds.

 2.     Terminal value concerns – As the car fleet is moving towards electric vehicles, investors are concerned that GVR’s core business will go away as they mainly sell equipment to service ICE (internal combustion engine) vehicles. Even though this transition will take decades, bears assume gas stations will not invest in new ICE fueling equipment. We feel comfortable with this issue for the following reasons:

a.       Gas retailers are not showing us any market concern. There are several publicly traded gas retailers: CASY, Couche-Tard (ATD/B CN), MUSA and TA. Also, GTY is a REIT that is focused on owning gas stations. As can be seen below, the stocks are trading at healthy multiples (significantly above VNT) and for the most part above their historical averages.

These stocks are highly sensitive to electrification, as they would get hurt from a decline in traffic as Electric vehicles will be charged at parking locations (home, work etc’) vs. gas stations.

 b.      According to BloombergNEF, the ICE car parc is expected to continue to grow until 2030 and will still be >90% of the total population. Most of the sellside estimates fall in the same ballpark. We are not going to see a step change in the car parc as there are many technological (battery/range) and infrastructure (charging equipment and electrical infrastructure) hurdles to overcome.

c.       Gas retailers’ business model is predicated on attracting customers to the retail store. Fuel profits typically account for 20-30% of total profits and fuel sales are used to attract customers. The assumption that retailers will stop investing in new equipment as the car parc evolves is flawed for the following reasons:

                                                                           i.      This is a competitive market. There are gas stations everywhere. New equipment attracts customers. Studies show that there is typically a 10% increase in traffic for the first year after new dispensers are installed in a gas station.

                                                                         ii.      The market is predominantly a break/fix replacement market in the US. There is an average life of ~12 years for a fuel dispenser in the market.

                                                                        iii.      Additional sales are driven by regulation / technological advancements. Digitalization of payment and video marketing are causing additional sales alongside SAAS offerings for the regulatory and logistic aspects of running a gas station.

d.      GVR has exposure to EV charging via investments in:

§   Tritium – a leader of DC fast charging solutions with ~2.7k fast chargers deployed in 30 countries. VNT has an option to buy the company in 2021.

§  Driivz – Provider of EV charging network management software that is OEM agnostics.  VNT has the option to buy the company in 2022

As we think about the future of EV charging, GVR has an advantage with gas retailers in the US due to their relationships and their ability to integrate their chargers with their payment system. If they can build enough scale and know-how, they can expand that competitive advantage outside their natural turf of gas retailers. M&A and focus will be key but their vast FCF generation and expertise should give them a competitive advantage compared to others.

5.     Valuation mismatch

-         As can be seen below, VNT’s valuation stands out compared to every other US cap goods company. Long term value concerns are relevant for several companies in the space but few are trading near VNT. We believe this is purely a function of the technical overhang and the stock will bounce to a more reasonable multiple relatively quickly

The disparity is even more evident when looking at margins and growth rates. Vontier ranks 11/39 in Gross Margins (2021), 7/39 in 2020 growth (as a sign of resilience) and 12/39 in terms of EBITDA margins.

Tax rate is also something that isn’t discussed with respect to VNT. It currently has a tax rate of 25% (vs. ~20% average for the group). FTV has a best in class tax department (that was led by the former ETN tax person who retired recently) and has 15.5% tax rate. Typically, when companies spin-off they do not have an efficient tax structure. We believe that with the internal tax know-how the company can shed 5-7 percentage points of tax rate which can drive additional upside. This is currently not part of our assumptions.

We currently assume EPS of $2.55 vs. consensus of $2.39 for FY 2021 as we believe the company is setting a low bar and will beat and raise all year. We apply a modest 16x multiple to get to our near-term PT of $41. 

-         There are no direct comps to VNT – but DOV owns its main retail fueling competitor (23% of sales) and trades at 19x 2021. FELE also has a fueling segment (22% of sales) and trades at 29x 2021).  Even SNA (comp to Matco) that has been very aggressive with customer and franchisee financings and does not have a franchisee growth opportunity is trading at 15x 2021.

Catalyst

1.       Technical overhang removed

-         As mentioned before, we believe that in the upcoming week the technical selling will be mostly complete and the stock can start moving towards a stabilized level towards what we believe is fair near-term value of $41.

2.       Earnings estimates for 2020 and 2021 are too low

-         We believe consensus is too low for Q4 2020 and 2021. GVR can grow organically in the teens for the next 2 quarters as gas retailers rush to meet the EMV regulatory change. Further, we believe the bar has been set very low for 2021 and the company can outgrow low expectations of LSD to flat organic growth.

3.       M&A

-         The company intends to deploy $1.5bn in the next 2-3 years. In the near term the company will de-lever from 3.0x net debt / EBITDA but we expect that within a year the company will start deploying capital. The company has the option to purchase Tritium in 2021 and Driivz in 2022.