With Net Debt and Trading at 40x 2021 Earnings, Mettler-Toledo Is Too Pricey
publication date: Nov 17, 2020
author/source: Callum Turcan and Brian Nelson, CFA
Image Source: Metler-Toledo
By Callum Turcan and Brian Nelson, CFA
On November 9, we increased our fair value estimate for shares of Mettler-Toledo International Inc (MTD) by a significant margin. Though our updated fair value estimate for shares is $870 each, MTD is trading at ~$1,190 at this time, well north of even the high end of our new fair value estimate range (~$1,040). We expect Mettler-Toledo to post greater than expected revenue growth and operating margin expansion over the coming years, which underpins our increased free cash flow growth forecasts for the firm from our prior valuation assessment, but shares still seem way to pricey even after the fair value estimate increase.
Mettler-Toledo manufacturers precision instruments used in laboratories, for industrial needs, and for food retailing applications. Some of its products used in labs include laboratory balances, liquid pipetting solutions, and automated laboratory reactors. The company’s laboratory instruments business generates about half of its revenue. Its industrial instruments include weighting instruments (scales) and inspection systems, among other products; this division accounts for about 40% of revenue. The balance of sales primarily comes from retail weighing solutions used in supermarkets, for example. Its sales are geographically diverse--~30% from Europe, ~40% from North/South America, and the balance from Asia and other countries. No end-customer accounts for more than 1% of sales.
Mettler-Toledo has number of major competitive advantages over its peers, in our view. For starters, the company’s sales/service network is extensive, and its products are offered in more than 140 countries. Not only this, but Mettler-Toledo may very well have one of the largest installed bases of weighing instruments in the world. High-margin service revenue is a key component to its operations and accounts for more than 20% of total sales across its business segments. Its track record/execution and global brand/reputation set it apart from competitors and drum up repeat business from satisfied customers. Switching costs for customers are high, too, and its track record of innovation is top notch. Mettler-Toledo holds over 5,000 patents and trademarks.
That said there were risks to the story that we had been overestimating with our prior fair value estimate. During 2019, for example, its operations in China accounted for ~20% of sales, ~30% of global production, and ~34% of total segment profit. The ongoing trade wars during the Trump administration coupled with the spread of the COVID-19 pandemic made us a bit too cautious on the potential negative impact on Mettler-Toledo’s business, and we had discounted future growth/profitability a bit too much, as we soon found out. For example, here’s what management said in its third-quarter press release about performance in China:
Outstanding growth in China and strong growth in our Laboratory business resulted in excellent performance in the quarter despite negative impacts on our business from COVID-19. Our strong product portfolio combined with innovative sales and marketing strategies are yielding very good results despite the overall challenging environment. With the benefit of our temporary cost initiatives as well as ongoing margin and productivity initiatives, we had a strong increase in Adjusted Operating Profit margins and excellent growth in Adjusted EPS. Finally, cash flow generation was also very robust.
Still, the COVID-19 pandemic has weighed negatively on Mettler-Toledo’s financial performance in 2020 as its GAAP revenues were down marginally year-over-year during the first nine months of 2020. However, Mettler-Toledo’s GAAP gross margin expanded by roughly 40 basis points during this period. Additionally, the company’s free cash flows held up well during the first nine months of 2020 as Mettler-Toledo generated $416 million in free cash flow during the first nine months of 2020, up from $330 million generated in the same period last year.
Our new higher top-line growth forecasts are supported by Mettler-Toledo’s growing presence in developing markets and rolling out new services/products in developed markets. Cost control measures and productivity initiatives underpin our expectations that Mettler-Toledo will be able to continue expanding margins at a faster pace than we had previously expected. On a non-GAAP basis, for example, Mettler-Toledo’s adjusted operating margin grew by ~250 basis points in the third quarter of 2020 on a year-over-year basis. Reasonably extrapolating continued improvements along these lines have had a magnifying impact on our updated fair value estimate.
Mettler-Toledo held a net debt position of ~$1.1 billion at the end of 2019, and while free cash flow has been very robust in recent years (averaging ~$400 million per year), we simply underestimated the resilience of its business through difficult times. During the firm’s latest earnings call, management noted that “(it) now expects full year adjusted free cash flow to be in the $600 million range” and some of those free cash flows will go towards share repurchases (we think management is overpaying for its shares). The company is targeting local currency sales growth in 2021 in the range of 4%-6% and adjusted EPS in the range of $27.50-$28.30 for the year.
As of this writing, shares of MTD are trading at ~$1,190, which is well above the top end of our updated fair value estimate range, which sits at ~$1,040 per share. Though we like Mettler-Toledo’s business, competitive advantages and outlook, we think investors have gotten way ahead of themselves. The firm exited September 2020 with a net debt load (inclusive of short-term debt) of ~$1.1 billion, and the stock is trading at more than 42x 2021 expected earnings per share! We may have been a bit conservative with our prior fair value estimate, but Mettler-Toledo seems very overvalued, in our view, despite its fantastic business.
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Callum Turcan and Brian Nelson do not own shares in any of the securities mentioned above. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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