Discover more from Analyzing Good Businesses
AGB 2023.7 - Ametek (AME)
Organic + Acquisitions Growth
Subscribe to AGB - One analysis of a good business every five weeks.
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 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.
Why is it a good business?
As a leading manufacturer of electronic and electromechanical devices, Ametek benefits from switching costs across its many business units. Many of the company’s products are imbedded into the manufacturing processes of its customers and have very few substitutes. Furthermore, within certain industries where regulatory compliance requires certification (like in aerospace), being a supplier of one of the few approved products provides room for pricing power.
This is evidenced in the company’s ability to command price increases above cost inflation. From 2017 (earliest when this was disclosed on earnings calls) to 2022, pricing has averaged 2.7% while costs have gone up 2.1% during this period, resulting in 0.6% separation. Even during the recent rise in inflation, the company has been able to increase prices above costs, and the net difference has been even higher than in previous years. Some of that has to do with the company’s recent decision to stock up on inventory and invest more into its global sourcing capabilities.
While many of Ametek’s individual business units are relatively small (hundreds of millions in revenues), they typically compete in oligopolistic markets. This allows the business units to command higher and more stable margins and achieve organic growth through product differentiation. Furthermore, many of its business units run capital light business models, even when considering R&D investments.
The company’s scale advantages at the corporate level (even though the individual business units are much smaller) allow Ametek to extract cost and revenue synergies from their acquisitions. After an acquisition is completed, the company implements its global sourcing capabilities to lower the cost structure (typically an impact of 20%-30% on just materials costs) and improve the supply chain of the acquired business. Oftentimes there is also consolidation of manufacturing capabilities (usually offshore) and back-office support functions.
The revenue synergies typically come from taking a localized product and applying the company’s global distribution capabilities. Many of Ametek’s smaller acquisitions don’t have efficient international distribution since it usually requires heavy investment. Ametek generates almost 50% of its revenues from international markets, with a large portion coming from Asia.
Returns on incremental capital?
Over the past 10 years, Ametek has spent 9% of its capital on capex, 15% on R&D and 75% on acquisitions. The company’s business units are generally capital light, with annual capex requirements of less than 2% of revenues. Two thirds of capex is used for growth capital related to increasing productivity or expanding manufacturing capacity. R&D investments are ~5% of annual revenues and result in the improvement of existing products and development of new ones.
On the acquisition front, Ametek’s process involves acquiring differentiated business in the $200M-$400M deal size range and improving underlying margins. This target range has only recently moved higher. The prior target was closer to $100M-$200M. The integration of the acquisitions are quick and efficient. EBITDA margins are brought up to the corporate average over the course of three years.
The company’s 40+ individual business units are tasked with sourcing M&A opportunities, usually in product adjacencies. The business units are supported by a corporate team of 11 dedicated M&A professionals.
Historically, acquisition multiples were in the 8x-10x EV/EBITDA range but have moved higher to 11x-13x in recent years as the company has grown to acquire larger businesses. Ametek targets a return on capital of 10% by year three, when the EBITDA margins for the acquired businesses are brought up close to the company average.
Over the past 10 years, Ametek has spent an average of ~$700M annually for acquisitions. Some years like 2018, 2019 and 2021 were busier than others. Here are some of the larger acquisitions that the company has highlighted over the years:
Navitar was acquired in 2022 for $240M or 11x EV/EBITDA. Navitar is a provider of optical components and imaging systems for the life sciences, industrial and robotics industries.
Abaco was acquired in 2021 for $1.35B or 13.5x EV/EBITDA. Abaco is a provider of mission-critical computing systems for aerospace and defense platforms.
Magnetrol was acquired in 2021 for $230M or 12x EV/EBITDA. Magnetrol is a provider of level and flow control solutions for the life sciences, oil & gas and food & beverage industries.
Gatan was acquired in 2019 for $925M or 13x EV/EBITDA. Gatan is a provider of advanced electron microscopy products for the life sciences and materials industries.
Tellular was acquired in 2018 for $525M or 13x EV/EBITDA. Telluar is a provider of telematics software for industrial logistics and IoT communications for residential security. The company has 65% recurring revenues.
FMH Aerospace was acquired in 2018 for $235M or 11x EV/EBITDA. FMH is a provider of engineered components related to fluids and gases for aerospace and defense markets.
Rauland-Borg was acquired in 2017 for $340M. Rauland-Borg is a provider of communications and workflow solutions for healthcare and education businesses.
Zygo was acquired in 2014 for $266M or 8x EV/EBITDA after synergies. Zygo is a provider of extreme precision optics for the physical sciences industry.
We estimate that Ametek generated returns on incremental capital between 10%-15% annually over the past 5 years. 2022 resulted in a slight pullback on returns due to supply chain issues and large M&A. The company decided to build inventory and diversify its supplier base starting in 2021 to support the company’s sales growth and fulfill its backlog obligations. Because of these actions, Ametek’s cash flow from operations was depressed in 2022 relative to where it should have been with a normalized supply chain.
To put this into perspective, Ametek’s annual increase in its inventories net of acquisitions averaged around $8M (with a range of -$60M to $77M) for the 10 years prior to 2021. In 2021 and 2022, the increases were $130M and $322M. When the inventory stocking reverses, assuming a normalization of the supply chain, the company should benefit in future years and returns should be elevated.
The size of M&A in a given year also has an impact on returns on capital. Because acquisitions are margin dilutive (usually have mid-teens% EBITDA vs. Ametek’s 25+%), a large amount of money spent on acquisitions could have a dampening affect on returns. This happened in 2021 with the Abaco acquisition, which was 13.5x EV/EBITDA before cost synergies, implying 1st year returns close to 7.5%.
M&A will continue to drive the majority of the growth going forward for the company. Because Ametek’s acquisition strategy is relatively more conservative, there seems to be more wiggle room for acquisitions to meet their return targets. The company generally makes smaller acquisitions (though that range has increased over the past 5 years), which would generally imply that the acquisition multiples are lower. Furthermore, the company’s quick work to improve margins after the acquisition makes the hurdle rate of 10% return on capital by year three much easier to meet.
What interesting about Ametek’s recent acquisition history is that most of the acquisitions have mainly been in the EIG segment. Of the 35 acquisitions the company has made from 2013-2022, 30 of them or 86% have been for EIG. A quick look at the assets by group shows that EIG has ballooned from 57% of all assets in 2013 to 78% in 2022. The company gets asked about this phenomenon from time to time, but there’s no lack of appetite from Ametek to acquire more EMG businesses.
The outsized growth in EIG has helped corporate margins move higher as EIG generally has higher margins than EMG. This is explained by EIG having more aftermarket content available in some of its business units, which tends to have higher margins than OEM components. That being said, EMG margins have recently improved over the past two years as automation has become a larger part of the group.
With revenues of $6.1B and a market cap of $35B+, Ametek still has opportunities to implement its growth model. By comparison, Danaher (understanding that they specialize in different industries) generated revenues of $31B in 2022 and has a market cap of $180B+. That’s not even counting the spinout of Fortive in 2016, which generated $5.8B in revenues in 2022 and has a market cap of $27B.
We’d argue that Ametek is undercapitalized and could spend more on acquisitions, but there are likely limiting factors like (1) the ability to integrate more acquisitions, (2) the number of quality deals available at any given time, and (3) the company’s goal to not overpay. When comparing debt/EBITDA ratios of Ametek vs. other conglomerates like Roper, Fortive and Idex, it’s not unreasonable for the company to increase its debt by one to two turns of EBITDA.
With a reinvestment rate between 65%-85% and a return on incremental capital between 10%-15%, we estimate that Ametek has increased its intrinsic value between 9%-10% over the past 5 years. As mentioned earlier, the returns for 2022 were a bit muted due to the investments in inventory and the large M&A deals in 2021. When normalizing for these two factors, the returns are on par with prior years and the reinvestment rates come down from the top of the historical range to more normalized levels.
What else is important?
What about cyclicality?
While Ametek owns differentiated businesses and can command pricing power, the company’s growth is still highly correlated with the industrial cycle. Most of Ametek’s business units are mid-to-late cycle, which means you tend to have larger swings in revenue and earnings growth in strong markets and larger drawdowns in soft markets. Ametek’s organic revenue growth vs. the multi-industry sector average shows this exact phenomenon going back the past 13+ years. Even compared to the other industrial conglomerates like Roper, Fortive and Idex, Ametek’s organic growth profile is subject to larger swings depending on the industrial cycle.
Ametek’s acquisition strategy does dampen some of the swings in revenue growth and earnings (assuming the environment allows for the company to acquire businesses that fit its criteria). Acquisitions related growth contributes more than 5% to total revenue growth and the company’s operational excellence programs allow for continued march towards higher margins. Ametek’s EBITDA margins have increased from 26% in 2013 to 29.6% in 2022.
Looking forward, acquisitions are the main source for upside optionality. With the company’s conservative balance sheet, there is still ample room for large acquisitions as long as they meet the company’s acquisition criteria. Increasing the debt level on the balance sheet could also be a source of outsized growth, especially since the company will need larger acquisitions to maintain the contribution to total revenue growth from acquisitions.
If you made it this far, I hope you received some value from reading our analysis. Please subscribe to the newsletter and share with anyone that would find it valuable. Thank you for your support!