Roper Industries $ROP
is one of the most interesting industrial stocks, not least because it
appears to be more of philosophical concept than a typical industrial
conglomerate. In essence, it's a collection of four disparate businesses
that operate within their own highly profitable niche markets. The
common philosophy behind each segment is that they are high-margin and
highly cash generative companies operating with relatively asset-light
business models. While this strategy has been working very well for
Roper shareholders so far, is the stock a buy right now?
Roper reports full-year results
In order to quickly outline how Roper makes money here is a chart of its segmental operating profits in 2013.
In order to quickly outline how Roper makes money here is a chart of its segmental operating profits in 2013.
Source: company presentations
Having disappointed in the previous quarter, Roper
reported some better numbers in the fourth quarter resulting in adjusted
revenue up 9% and net earnings up 11% for the full year. Moreover,
there are six key reasons why Roper can do well in 2013.
Margins and cash flow, increasing software, and growing orders
First, Foolish investors should appreciate how well the management has increased margins and cash-flow generation. Roper's gross margin was around 58% for the full year, but note how it has increased over the last few years, particularly when compared to companies like Danaher and Dover Corp $DOV . The latter two are not perfect comparisons, but they do provide a good benchmark to judge whether Roper's gross margin performance is merely a function of the economy or not.
First, Foolish investors should appreciate how well the management has increased margins and cash-flow generation. Roper's gross margin was around 58% for the full year, but note how it has increased over the last few years, particularly when compared to companies like Danaher and Dover Corp $DOV . The latter two are not perfect comparisons, but they do provide a good benchmark to judge whether Roper's gross margin performance is merely a function of the economy or not.
Clearly, Roper is outperforming its peers in terms
of gross margin, so this isn't just about the economy. Moreover, its
free cash flow generation and conversion is outstanding. Roper generated
$760 million in free cash flow last year, representing a conversion
rate of 141% of its net earnings. Looking into 2014, management
predicted that operating cash flow conversion would be 140% of earnings.
Based on my calculations, and Roper's guidance for full-year EPS, its
free cash flow will amount to around $8.35 in 2014. In other words, it's
on a forward free cash flow yield of around 6%.
Second, one of the reasons that Roper is generating
increased margins and cash flows is due to its increasing amount of
software sales. On the conference call, CEO, Brian Jellison outlined
that "If you look just like the SaaS businesses, pure software
businesses, we get more than a fourth of the Company's EBITDA out of
that." Moreover, he also argued that if application software was
included, the figure would be closer to half.
Usually, software as a service, or SaaS, based
businesses tend to generate recurring revenues over longer periods.
Indeed, Jellison disclosed on the conference call that Roper has "a lot
of recurring revenue in radio frequency and in medical" and the fact
that deferred revenue jumped 12.6% to $209 million bears that out. This
implies that Roper is increasing the amount of long-term value it gets
out of its orders.
Third, Roper's order book looked good in the last
quarter, its book-to-bill was 1.01 versus 0.95 in the fourth quarter
last year.
| Q4 2013 | Order Book Growth |
| RF technology | 11% |
| Industrial technology | 3% |
| Medical and scientific technology | 12% |
| Energy systems and controls | 14% |
| Company | 10% organic, 16% reported |
Source: company presentations
Recovering businesses, underlying guidance is better, end markets improving
Fourth, the businesses that had difficulty in the previous quarters managed to recover well in the quarter. Imaging (medical and scientific technology) orders were surprisingly strong with a double-digit increase. Meanwhile, its nuclear inspection business, Zetec, was described on the conference call as being weak "as expected", but its orders "tell us that really the worst is behind us". These two nuggets of good news help to de-risk the stock somewhat.
Fourth, the businesses that had difficulty in the previous quarters managed to recover well in the quarter. Imaging (medical and scientific technology) orders were surprisingly strong with a double-digit increase. Meanwhile, its nuclear inspection business, Zetec, was described on the conference call as being weak "as expected", but its orders "tell us that really the worst is behind us". These two nuggets of good news help to de-risk the stock somewhat.
Fifth, superficially Roper disappointed the market
by issuing full-year EPS guidance of $6.05-$6.25 when the analyst
consensus was $6.20. However, there is an extra tax charge of $0.20 in
2014, without this charge the guidance would have been a more impressive
$6.25-$6.40.
And finally, prospects in some of its end markets
are looking better. For example, its water pumps business, Neptune
(industrial technology), will benefit from increased housing starts.
According to Halliburton and Baker Hughes
the U.S. oil and gas rig count will at least stabilize in 2014, and
this could be a positive for elements of Roper's energy systems and
controls segment.
Is Roper a good value?
On a P/E basis, Roper is not the cheapest stock in the sector.
On a P/E basis, Roper is not the cheapest stock in the sector.
ROP P/E Ratio (TTM) data by YCharts
Moreover, on a forward P/E ratio of around 22 times
earnings, it's hard to argue that it is anything more than fair value
at the moment. On the other hand, Roper is a high quality company and
for the reasons articulated above, it has upside earnings potential in
2014. Foolish investors may want to keep an eye out for any buying
opportunity should it dip from here.
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