Breaking up, despite what the song says, isn’t always hard to do. Sometimes it’s just what’s needed to get out of a rut.
That’s the case with Fortive (ticker: FTV), the industrial conglomerate spun out of Danaher (DHR) in 2016. Now, Fortive is set for a spinoff of its own. On Oct. 9, it plans to hive off its transportation business into a new company, Vontier (VNT). The move is straight from Danaher’s playbook, which calls for buying companies and spinning them off to generate shareholder value. Usually it works.
Fortive stock, trading at $72, isn’t acting like it will. Since the spin was announced on Jan. 15, the stock has lost 6%, compared to Danaher’s gain of 29%, and the S&P 500 index’s 0.3%. That may suggest that investors are waiting to see how the separate pieces trade, and creating an opportunity to buy Fortive ahead of the spin, and get two great companies once it’s done.
Fortive, which makes hundreds of products for dozens of end markets, isn’t a household name. But consumers pump gas from pumps made by Fortive brands, tractor-trailers have telematics from Fortive units sending data to headquarters, and electricians can buy voltage meters made by Fortive at the hardware store. It’s a high-quality industrial that helps measure and control critical industrial processes.
New Fortive will be more focused after it completes the split. Fortive will be left with professional instrumentation segments focused on measuring and monitoring business processes. Need to know if a turbine is vibrating too much? Fortive has a solution. Data collection and analysis will become a larger portion of the instrumentation business. Software sales will make up a “low-teens percentage” of new sales, which means Fortive will have a solid base of recurring sales that can translate into better-than-average multiples.
Fortive isn’t that cheap. In its current form, the stock trades for about 20 times 2021 earnings estimates of $3.68 a share, a small discount to its historical average. That might seem fair, but the price/earnings ratio for the S&P 500 is higher than it has been historically. As a result, Fortive is trading on par with the market, despite a historical 20% premium. Fortive’s peer group is trading at a 20% premium to its historical average. In short, the market is down on Fortive. That could change once the spin is completed.
Vontier is key to unlocking value. It will include Fortive’s Gilbarco Veeder-Root and Orpak Systems divisions, which make fuel pumps. It will take the telematics, which helps commercial fleet operators track vehicles, and the Matco Tools business, which sells tools to mechanics. In other words, the new company is all about transportation.
Given the shift toward electric vehicles, that might not seem like the best place to be, but RBC Capital Markets analyst Deane Dray disagrees. “The cursory, and incorrect, assumption is the Veeder-Root business is biased to internal-combustion engines,” says Dray. “This will be a well run business.” And, he points out, the Vontier portfolio will change over time.
Vontier knows the internal-combustion business might be a melting ice cube. It’s investing in fast-charging EV technology and software to manage electricity at next-generation fueling stations. While it’s easy to slap a low multiple on Vontier and be done with it, Morgan Stanley analyst Joshua Pokrzywinski argues that the spin may mean investors put a higher multiple on the stock. “Now that investors are forced to have an opinion on Vontier again, he says, “There’s substantial room for sentiment to improve.”
If he’s correct, investors will walk away with two companies that could be worth more than Fortive was before the split. Vontier’s peer group, which includes Dover (DOV) and Trimble (TRMB), trades for roughly 20 times estimated 2021 earnings. Fortive’s new peer group will include Rockwell Automation (ROK) and Ametek (AME). That group trades for about 29 times 2021 estimated earnings. That implies a 15% to 20% bump in the stock price. Pokrzywinski goes even further: “Investors are essentially getting Vontier for free.” He has an Overweight rating on Fortive, with an $83 price target.
“ Management skill is what matters in multi-industry land. ”
Often, it makes sense to take the money and run once a split occurs. That isn’t the case with Fortive and Vontier. Debt at both companies will be below average when the spin is completed. And the companies practice the Danaher Business System, which focuses on ensuring that companies are as lean and efficient as possible.
Danaher’s lean techniques focus on continuous improvement applied to all aspects of a business, harkening back to W. Edwards Deming and the post-World War II Japanese manufacturing philosophy of Kaizen. It delivers results: Fortive margins are six percentage points higher than the average S&P 500 industrial firm. Danaher stock has returned 17% a year on average for 20 years, far better than the 6% and 7% respective average annual returns of the S&P and Dow Jones Industrial Average.
This year has been tough for Fortive. Earnings are set to dip in 2020, hitting $3.21 a share. But that’s not unexpected, given the pandemic. Earnings could hit $3.68 a share in 2021, up 6% from 2019 levels. What’s more, management just guided third-quarter sales above where Wall Street was modeling. That should make both Fortive and Vontier appealing down the road. “Management skill is what matters in multi-industry land,” says Dray. “You are making an oversize bet on a management team to generate growth across a diversified portfolio.”
Write to Al Root at email@example.com