In the realm of spinoff companies, where hidden gems await discovery, every so often a standout opportunity emerges—one that commands attention for long-term investment. The latest spinoff from Danaher Corporation, Veralto, represents such a moment. This is a stock that not only deserves but also demands consideration for inclusion in your portfolio.
For those familiar with my earlier analysis of (VLTO), you'll be aware that I acquired shares at the time of its spinoff and capitalized on its rise from the early $70s following the separation. My admiration for the Rales brothers is no secret, and (DHR) stands as another key investment I recommend considering. For those less acquainted with DHR, allow me to offer some insight into this dynamic company and why it merits attention in your portfolio.
Danaher
DHR has become a world leader in science and technology, thanks in large part to the strategic vision and creative management of Steven and Mitchell Rales. They changed the company by buying undervalued assets strategically, starting in the early 1980s. They focused on releasing potential through operating efficiency and the use of the DHR Business System (DBS). This method, which was based on the Japanese Kaizen model, put an emphasis on lean manufacturing, making money, and growth. It helped (DHR) grow from a small conglomerate to a global powerhouse in many different areas. The Rales brothers put long-term value and growth ahead of short-term gains. They integrated and improved each purchase to raise (DHR)'s market value and make it known around the world for quality. The Rales brothers with (DHR) have been responsible for many spinoffs. The real key to following value is where the brothers put their money. (DHR) (parent company), (ENOV), (ESAB), and (FTV) are all spins that have performed. They have a material financial interest in (VLTO) too.
Veralto
Spun off in October 2023, (VLTO) is a global leader in essential technologies dedicated to safeguarding the world's vital resources. Their mission is to create a lasting positive impact by addressing critical challenges related to water and product quality. As part of their commitment to improving and preserving vital resources and ecosystems, (VLTO) is a leader in two important areas: water quality and product quality, and innovation.
Several important aspects make up VLTO's commitment in the water quality segment:
Here, (VLTO) presents state-of-the-art technology for municipal and wastewater treatment, with the goal of improving water treatment procedures for communities and cities. This will help with public health and environmental preservation by assuring efficient purification and effective management of wastewater. Lakes, rivers, and other natural water bodies are part of the company's focus as it works to protect their quality by implementing solutions to track, enhance, and manage water conditions. This helps to avoid pollution and restore ecosystems.
To keep an eye on the state of our oceans and watersheds—which are enormous ecosystems in and of themselves— (VLTO) employs cutting-edge technological solutions to tackle problems like water contamination, inefficient resource management, and other environmental dangers.
Quality and Innovation in Products Division:
In this segment, we see how (VLTO) plays a part in the worldwide supply chain by checking the following for authenticity and safety:
Food Safety: (VLTO) is an industry leader in preventing contamination and guaranteeing that food items are safe from farm to table. They achieve this by utilizing technology to control the complete food manufacturing process. In the pharmaceutical industry, (VLTO) is introducing solutions to authenticate medications, which helps fight the spread of counterfeit drugs and protects public health by making sure that true, safe pharmaceuticals are available.
The Outlook
Due to around 55% of its income coming from recurring sources and its favorable margins, (VLTO) will be in a strong position to capitalize on its leadership in sectors with high growth potential in a very unstructured industry. Because of its distinctive products, (VLTO) can fortify its position and generate synergies as a separate organization. Furthermore, new product development, increasing water quality concerns, ESG (Environmental, Social, and Governance) initiatives, and strict regulatory rules would all serve as long-term accelerators for growth, but they would be even more effective with a favorable secular tailwind.
Recent Earnings
(VLTO) reported earnings on February 6th this year. Despite (VLTO)'s projection of a flat outlook for Q1 FY24E due to rising costs, management anticipates a gradual recovery, driven by the expected demand resurgence in H2 FY24, especially in the Product Quality and Innovation (PQI) segment. They remain committed to achieving low single-digit growth, expecting healthy margins, and maintaining low leverage. Furthermore, VLTO is actively seeking merger and acquisition opportunities to bolster its portfolio through strategic capital investment. (VLTO) remains a promising candidate for long-term growth and a potential future separation (spinoff) of the two divisions, which could prove a doubling of the stock price in a year to two years.
- In its Water Quality segment, (VLTO) reported a growth of 3.4% to $782 million in 4QFY23 from $756 million in 4QFY22, with core sales up by 2.1%. The full-year 2023 saw an increase to $3,039 million from $2,887 million in FY22, marking a 5.3% growth, with core sales rising by 5.1%. Despite ongoing weakness in China, management is optimistic about a recovery, noting that the market has likely bottomed out. North America and Europe, in contrast, exhibit consistent demand across industries.
- The Product Quality Innovation (PQI) segment saw a 2.9% increase to $506 million in 4QFY23 from $492 million in 4QFY22, with a core sales growth of 1.1%. The full-year figures for 2023 were relatively flat at $1,982 million compared to $1,983 million in FY22, with core sales decreasing by 1.1%. PQI is facing challenges in consumer packaging demand, though gains in marking & coding are offsetting declines in packaging & color.
As of 4QFY23, the total debt stands at ~$2.6bn and a cash balance of $762m, translating into a net debt of $1.9bn and considering the adj. EBITDA of $1.2bn, net leverage stands close to 1.54x. Further, a healthy free cash flow conversion of more than 100% will further strengthen their balance sheet and reduce leverage.
For Q1 FY24E, management has guided flat core sales growth with an adjusted operating margin between 23.0% and 23.5%. For the full year 2024E, the company is guiding low-single-digit (LSD) growth from the core business with an improvement of 50–75 bps in operating margin. This improvement in margin accounts for the incremental standalone cost and other corporate expenses worth ~$100m. At the same time, free cash flow conversion is projected to be ~100%.
Despite (VLTO)'s projection of a stable outlook for Q1 FY24E due to rising costs, there's an anticipated gradual upturn. I'm confident in management's commitment to achieving low single-digit growth, particularly with a demand resurgence expected in H2FY24 for Product Quality Innovation (PQI), alongside maintaining healthy margins and low leverage. Additionally, (VLTO)'s dedication to seeking mergers and acquisitions presents a promising avenue for strategic portfolio enhancement and value creation. This approach positions (VLTO) as a solid investment for those looking for long-term gains and strategic growth opportunities.
