Veralto: Growth Tailwinds Remain Intact

seekingalpha10-30

I maintain a bullish view of Veralto due to strong demand tailwinds, core sales growth, and expanding adj EBITDA margins.3Q24 results showed $1.31 billion in revenue, 4.6% core sales growth, and ...

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After reviewing the latest results, my view remains bullish for VLTO. The business should continue to ride on the strong demand tailwinds, leading to improved core sales growth and expanding adj EBITDA margins. 3Q24 results update VLTO 3Q24 revenue came in at $1.31 billion, with core sales growth of 4.6% y/y, which landed at the high end of management guidance (low to mid-single digit growth). By segments, water quality [WQ] came in at $801 million, up 3.6% y/y, and product quality and innovation [PQI] revenue came in at $513 million, up 6.3% y/y. 3Q24 also saw the benefits of operating leverage, as seen from the margin expansion across adj EBIT and adj EBITDA by 170 bps and 200 bps, respectively, leading to an EPS beat of $0.89 vs. $0.85 and adj. EBITDA of $327 million vs. $341 million. Management issued its 4Q24 guidance, where it calls for core sales growth of a low-single to mid-single digit percentage, which at least drives FY24 revenue growth to be in the low-single-digits range (FY24 core sales growth guided to be low-single-digits). Accordingly, management also raised their FY24 adj EPS guide (this is the third consecutive quarter they raised guidance) from $3.37-$3.45 prior to $3.44-$3.48. Demand momentum remains strong in the WQ segment Growth in the WQ segment continues to be solid with no signs of slowdown in sight. I stick to my view that this segment has a long runway of growth ahead; in particular, chemical treatment continues to show strength, growing core sales by 9% y/y (~2x the rate of consolidated core sales growth). In fact, I have turned more bullish on the growth outlook as I figured out another growth catalyst (aside from the drivers I have mentioned previously: ultrapure water for the semiconductor industry and clean water for drinking purposes). The catalyst is the demand for more power generation, and this demand stems largely from increased data center [DC] capacity and AI clusters. Per this JP Morgan report, large DC uses up to 5 million gallons of water/day, and this is equivalent to serving a town of up to 50,000 people, and this is on top of the billions of gallons of water needed to facilitate the manufacture of conductor chips. While non-treated water can be used to drive hydropower (all it requires is the kinetic energy from the moving water), the efficiency of the hydraulic turbine will be negatively impacted due to wear and tear. In addition, climate change has resulted in hotter weather that requires more water for cooling purposes. Also, remember that DC and AI clusters both require significant water for cooling purposes. We know for a fact that this is translating into demand for VLTO, as the 3Q24 earnings report noted increased orders for this end market (chemical treatment). Recovery momentum in PQI segment continues I also continue to expect growth acceleration in the PQI segment. To put more meat into the segment performance, marking and coding core sales saw 4.6% y/y growth as strength in consumables continues to be strong. Given that the underlying demand follows how strong consumer spending power is, I have a positive view going into FY25 as inflation in VLTO key regions continues to trend downwards. VLTO should also enjoy the benefit of a step-up in sell-in revenue as product manufacturers that put off their CAPEX plans previously come back online (restart their manufacturing lines), driving volume sales for equipment (which appears to already be happening).  Yes. We really like the PQI business. And I think if you look at its history over the past 20 years, we've only had sort of three periods of contraction. So it tends to hold up really well through various economic cycles. And what I would say in comparing this recovery to prior recoveries is, prior recovers was more of a V-shaped recovery kind of fast down and fast up. I think what we've seen sort of post-pandemic is a gradual and steady, progressive sequential improvement. So it's more U-shaped than V-shaped. But we continue to be encouraged by the leading indicators that we see in terms of, volume of -- that's published from our top CPG customers, and demand continues to consistently grow and that's also supported by the sales out that we've seen from our recurring revenue and then the two sequential quarters of equipment growth. So again, I think it's a slow and steady wins the race here. We're not going to see any huge inflection points, but we're encouraged by certainly what we see in the market today. ... As a printer sales, we feel really good about some of that engagement with the customers, that equipment volumes coming back... From: 3Q24 earnings transcript  Acquisition of TraceGains is a strategic fit for the PQI segment Also relating to the PQI segment, I am a fan of the decision to acquire TraceGains ($350 million deal). For those that are unaware, TraceGains is a software that helps brands meet strict compliance regulations for food and beverage regarding ingredients and traceability. On the financials, it is very accretive, as TraceGains has grown revenue at a 20% CAGR over the past 3 years and is expected to achieve ~$30 million in sales in FY24, of which 95% of revenues are recurring, and the business has an 80% gross margin. The important highlight is the synergies that VLTO can reap from this acquisition. Although TraceGains' revenue size is relatively small, it has a massive installed base of >80k locations and has data on >550k ingredients. VLTO Leveraging this vast amount of data enables VLTO to offer an integration solution, allowing it to extract revenue synergies by cross-selling to both enterprise accounts (TraceGains to esko's customer base) and mid-market (esko to TraceGains customer base). From a competitive standpoint, this should enhance the stickiness of the software platform, resulting in stronger pricing power for VLTO over time, especially as the installed base grows. Valuation Redfox Capital Ideas While the VLTO share price has reached close to the levels I was expecting previously, I believe there is still room for upside looking at how 3Q24 has performed. Reflecting my positive views, I have upgraded my growth outlook for FY25/26 by 25/50bps accordingly, bringing growth closer to mid-single-digits (benchmarked against the 4Q24 core sales guided range). Note, I assumed FY24 core sales growth to be 4% despite management guidance for low single-digits because VLTO has beat guidance over the past 6 quarters (using reported figures vs. consensus, which follows management guidance, as a benchmark). I have also upgraded my adj EBITDA margin assumptions, as year-to-date performance has well surpassed my original FY24 estimates. Assuming 4Q24 does the same margin as 3Q24, FY24 adj EBITDA margin should come in at 26%, setting a higher baseline for FY25/26 to expand upon. All of this should justify VLTO continuing trading at this multiple of 20x forward EBITDA, which is a premium against Xylem Inc. (closest peer to VLTO) that trades at 17.5x with a similar growth outlook but a lower EBITDA margin. Risk Integration of the newly acquired business-TraceGains-may not be as smooth as it should be, resulting in a delay in recognizing revenue synergies. The timing of consumer spending recovery may take longer than expected if the macro situation continues to stay pressured (this could happen if the Fed decides not to cut rates). Conclusion  My view for VLTO is a buy rating as it continues to show solid performance in both its core segments (WQ and PQI). The strategic acquisition of TraceGains is also a positive move that should support growth. While the share price has reached my previous target, I still see an upside as I revised my assumptions upwards to reflect the strong fundamentals and growth prospects. The risks to note are macroeconomic headwinds and integration challenges associated with the recent acquisition.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2479264318"}