AGB 2023.7 - Ametek (AME)
Organic + Acquisitions Growth
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In our study of different industrial conglomerates, it’s interesting to see the nuances in the different capital allocation strategies. We’ve studied Roper, HEICO and TransDigm and plan to study others in future write-ups. Because of Ametek’s choice of acquisitions (mainly the relatively smaller deal sizes but also specific industries), the company seems to have ample room for operational improvement and internal reinvestment opportunities. This can be evidenced by the Ametek’s returns on capital and organic growth cadence. The smaller deal sizes also allow for lower multiples on acquisitions (though they have been increasing recently), which make Ametek’s internal return targets easier to achieve.
Ametek
Ametek is a leading industrial conglomerate specializing in electronic instruments and electromechanical devices. The company is a serial acquirer of businesses that have technology differentiation within specific industrial niches. The acquisitions typically participate in oligopolistic markets where they can command up to 30% market share. Ametek then improves the cost structures, increasing margins over a three-year period, and reinvests capital to continue their growth through new product introductions. Many acquisitions are complementary to existing business units.
The company’s business units are categorized into two main groups, Electronic Instruments (EIG) and Electromechanical (EMG). EIG makes up 69% of revenues and EMG 31%, though this was closer to 50/50 over a decade ago. Under these two groups are 4 subgroups. Two and a half of these subgroups, Process, Power & Industrial and Aerospace fall under EIG. The other one and a half of these subgroups, Automation & Engineered Solutions and Aerospace fall under EMG.
The Process segment makes up 72% of EIG and 50% of total revenues. Included in this segment are test and measurement devices for life sciences, power generation, technology manufacturing and oil & gas industries.
The Power and Aerospace segment makes up 28% of EIG and 19% of total revenues. Included in this segment are systems, sensors and instruments that are used in the aerospace, power and industrial markets.
The Automation & Engineered Solutions segment makes up 71% of EMG and 22% of total revenues. Included in this segment are motion control systems, motors, heat exchangers and pumps for the technology, industrial and life sciences sectors.
The Aerospace segment makes up 29% of EMG and 9% of total revenues. Included in this segment are thermal management and MRO services to commercial aerospace and defense industries.
And to not make it any more confusing, there are end market verticals that the company discloses from time to time. Healthcare is a large segment at ~15% of revenues. Aerospace is also ~15% of revenues and within this segment is 35% defense, 25% commercial OEM, 10% business jet and 30% MRO. Energy is 5%, down from 10% a decade ago. And Automation has increased from 7% to 12% during the same time period.
Over time, the company has undergone a slow transformation from businesses that are more cost-driven to businesses that have product and technology differentiation. And in that transformation, there have been more opportunities for secular growth. A lot of that growth has come from increasing exposures to Automation, Aerospace and Healthcare. These verticals have more aftermarket content opportunities, which we know tend to have better margins profiles. This has come at the expense of a slower growing Energy business.
Ametek’s growth model targets double digit percentage growth in revenue annually. Organic revenue growth contributes close to mid-single-digits and acquisitions make up the remainder. The company has failed to meet its target over the past 10 years due to the industrial slowdown in 2015/2016 and the Covid-19 lockdowns in 2020. Organic revenue growth averaged just 2.5%, while acquisitions growth contributed 5.2%. Just excluding 2020, the company gets closer to its growth model with 4.2% organic growth and 5.3% from acquisitions.
Organic revenue growth comes from new product development and price increases. The company regularly touts its vitality index, which is the percentage of revenues attributed to new products introduced in the past three years. From the earliest that the company has disclosed this metric, the vitality index has moved higher from 14% in 2004 to 27% in 2022. New product introductions also allow for price increases ahead of cost inflation.
On the bottom line, Ametek targets doubling its earnings every 5 years, implying margin expansion off of its annual revenue growth targets. A large part of the margin expansion comes from what the company calls Operational Excellence. Ametek has a series of initiatives in place for its business units (especially its newly acquired ones) to improve margins each year. Some practices include lean manufacturing, global sourcing and procurement, value engineering and digitization. Through these efforts, the company reduces costs in the range of $90M to $150M annually, which equates to roughly 1.8%-3.8% of revenues. Offsetting this improvement in margins are the company’s acquisitions that are usually margin dilutive.
Ametek’s acquisition strategy is self funded and not heavily reliant on ever increasing debt coverage ratios. Because the company’s typical acquisition size is relatively small, the lower multiples paid allow Ametek to generate healthy returns, especially after accounting for cost synergies. Ametek’s debt/EBITDA ratio has remained in a range between 0.7x-1.6x over the past ten years. The company consistently has over $1B-$2B of excess capacity to spend on acquisitions and Ametek is underleveraged vs. its peers.