By:
Derek Gross, AIM Student at Marquette University
Disclosure:
The AIM Equity Fund currently holds this position. This article was written by
myself, and it expresses my own opinions. I am not receiving compensation for
it and I have no business relationship with any company whose stock is
mentioned in this article.
Summary
• Novanta Inc. (NASDAQ: NOVT) is a global supplier of technology
solutions to both the healthcare and industrial OEM manufacturers.
• The company reported
earnings on August 6th, meeting consensus EPS estimates on the dot
at $0.54 and slightly beating sales estimates at $155m v. $154m est.
• The share price has
nearly doubled over the last 24 months, fueled by a strong diversification of
business. The Vision segment has seen sales growth of over 90%, while the
Precision Motion segment has grown by over 50%.
• On June 24th,
Novanta announced they would acquire Arges GmbH, a German manufacturer of laser
scanning subsystems used in medical applications, for a purchase price of $37.6
million.
• This stock is at the
far end of the growth spectrum. Novanta has seen sales and net income more than
double since 2012, and its multiples have skyrocketed relative to competitors
and historical averages over the past two years.
Key
points:
Novanta Inc. provides
core technology solutions to manufacturers to medical and advanced technology
equipment manufacturers. The company seeks to innovate what they dub as
“mission critical technologies” to improve factory efficiency and medical
success. The company reported Q2 earnings on August 6th, with
quarterly revenue up 3.2% YoY, but down 1.2% since last quarter. Sales have
been stagnant as of late, with quarterly revenue only up 6.0% over the past 7
quarters. Novanta has proved resilient in the face of a mixed bag of
developments in the macroeconomic landscape. Although medical market spending
saw double digit growth in the second quarter, industrial spending is a
legitimate concern moving forward. The Purchasing Managers Index (PMI) is at
its lowest level since early 2016 amid economic uncertainty. Bookings are
proving hard to come by for the microelectronics segment of Novanta’s sales mix
(10% of revenue). An overall 30% decline in the microelectronics sector with
further declines forecasted by management are not appealing to me as an
investor.
Although I may strike a
pessimistic tone, the stock has performed well since being added to the
portfolio in March of 2018. The share price has nearly doubled over the last
two years, while we have enjoyed a ~53% return. The driving force behind the
share price spike has been the growth of both the Vision and Precision Motion
segments, which have grown over 90% and 50% in the past two years,
respectively. Of the three segments, I expect future growth to come from the Vision
segment, which primarily supplies medical customers. This segment has been less
affected by industrial headwinds and trade concerns, and has experienced
continued success in new product launches (new product revenue YTD increased
75% YoY). I expect this segment to continue to increase its share in the sales
mix. Decreasing bookings and tariff exposure make me skeptical of the Photonics
and Precision Motion segments capability for near-term growth.
In 2019, Novanta has
closed on three acquisitions to bolster their new product offerings, which have
been a source of consistent growth. The purchases of Ingenia for $16.2 million,
Med X Change, Inc. for $21.8 million, and Arges for $37.6 million have been a
significant use of cash and have added to a modest debt load. Arges was by far
the biggest acquisition, with an additional future payment of ~$38 million
likely due in mid-2020. Part of management’s strategy has been to diversify and
decrease exposure to trade sensitive markets through acquisitions, and it looks
like they are executing on this strategy.
What
has the stock done lately?
After reporting earnings
on August 6th, the stock fell nearly 10% over the next several days
in response to disappointing commentary from management. Macroeconomic
headwinds remain a significant concern moving forward, and the market has
reflected that in the stock price. Novanta rebounded from a disappointing
August with a stellar September, driving the share price up more than 13%. The
stock has more than outperformed the broader market rally, as the Russell 2000
Growth index is up only 5.4% MTD. The company is not set to report earnings
until November 11th, so I don’t expect any significant price swings
until then.
Past
Year Performance:
Source:
FactSet
My
Takeaway:
I believe it may be time
for us to realize our gain on Novanta. The fund has realized a 53% gain from
Novanta since its addition to the portfolio, and is still trading relatively
near its July all-time high. The stock is simply too ‘growthy’ for me to stomach
in the current late-cycle climate. Management has relied on acquisitions to
inorganically grow revenues in the midst of macroeconomic uncertainty, and I am
not confident this strategy can continue to work in the future. High growth has
already been priced into the stock, and a sizeable drop in price could occur if
sizeable market expectations are not met. Additionally, management has been
artificially boosting earnings through questionable accounting. The subtraction
of ‘unusual expenses’, mainly arising from a continued history of M&A
activity, have provided EPS increases in each of the past 18 years! Despite the
artificial increases in earnings, the stock is trading at a 52.6 P/E multiple
and a 27.0 EV/EBITDA multiple, significantly higher than historical and peer
averages. For these reasons, I think it’s time to move this stock out of the
portfolio and add a value stock that is more suited for the late-cycle economic
environment.
Source:
FactSet
