In the vast universe of spinoff companies, where lucrative opportunities linger just beneath the surface, there emerges, at times, a true standout—a gem worthy of long-term investment. Enter, Veralto, the latest offspring from the powerhouse Danaher Corporation. This stock, Veralto, is not merely deserving of attention but demands it, beckoning inclusion in any prudent investor’s portfolio.
For those acquainted with my prior exploration of VLTO, you are well-aware that I invested in shares at the time of its spinoff, riding the wave up from the early $70s post-separation. My admiration for the Rales brothers is no secret, with Danaher Corporation (DHR) being another key investment in my recommended watchlist. For those unfamiliar with DHR, allow me to illuminate this dynamic enterprise and explain why it should be on your radar.
Danaher’s Remarkable Journey
Through the visionary leadership of Steven and Mitchell Rales, Danaher (DHR) has evolved into a global magnate in science and technology. The Rales brothers initiated a transformation within the company by astutely acquiring undervalued assets, starting their journey in the early 1980s. Their strategy focused on unlocking potential through operational efficiency and the implementation of the DHR Business System (DBS), a method inspired by the Japanese Kaizen model. This approach emphasized lean manufacturing, profitability, and expansion, propelling Danaher from a modest conglomerate to a worldwide force across various sectors. The Rales brothers prioritized long-term value and growth over short-term wins, meticulously integrating and enhancing each acquisition to elevate Danaher’s market standing and establish a reputation for excellence globally. The Rales brothers, with Danaher, have orchestrated numerous spinoffs, marking a testament to their astute investment decisions. The key to identifying value lies in following where the Rales brothers place their bets—Danaher (the parent company), Enovate, ESAB, and Fortive are all spinoffs that have resonated successfully. Their substantial financial stake in Veralto (VLTO) signifies a promising trajectory ahead.
Unveiling Veralto’s Narrative
Born from a spinoff in October 2023, Veralto (VLTO) emerges as a global front-runner in essential technologies dedicated to safeguarding the world’s precious resources. Aligned with a mission to make a lasting positive impact by addressing critical challenges concerning water and product quality, Veralto stands at the forefront of two pivotal domains: water quality and product excellence.
Championing Water Quality:
Veralto (VLTO) leads with cutting-edge technology for municipal and wastewater treatment to enhance water treatment processes for communities, fortifying public health and environmental preservation through efficient purification and wastewater management. Encompassing lakes, rivers, and natural water bodies, the company’s initiatives aim to safeguard water quality by implementing solutions for monitoring, enhancing, and managing water conditions, averting pollution and restoring ecosystems.
To surveil our vast oceans and watersheds, veritable ecosystems in themselves, Veralto (VLTO) deploys innovative technological solutions to combat water contamination, inefficacious resource management, and other environmental perils.
Excellence and Ingenuity in Product Division:
Within this sphere, Veralto (VLTO) plays an integral role in the global supply chain, ensuring authenticity and safety through:
Food Safety: Pioneering in preventing contamination and ensuring food safety from farm to table, Veralto (VLTO) employs technology to oversee the entire food production process. In the pharmaceutical realm, Veralto (VLTO) introduces solutions to authenticate medications, combatting counterfeit drugs and upholding public health by ensuring the availability of genuine, safe pharmaceuticals.
Navigating the Future
With approximately 55% of its revenue stemming from recurrent sources and boasting favorable margins, Veralto (VLTO) is strategically positioned to capitalize on burgeoning sectors within a fragmented industry. Armed with distinctive products, Veralto (VLTO) can consolidate its position, leveraging synergies as an independent entity. Moreover, the trajectory of new product development, mounting concerns around water quality, ESG (Environmental, Social, and Governance) imperatives, and stringent regulatory standards, all serve as long-term growth catalysts. A prevailing secular tailwind would further amplify the efficacy of these accelerants.
Recent Financial Performance
Following the earnings report on February 6th this year, Veralto (VLTO) projects a stable outlook for Q1 FY24E amid escalating costs; however, management anticipates a gradual recovery bolstered by a resurgence in demand expected in H2 FY24, particularly within the Product Quality and Innovation (PQI) segment. Committing to achieving modest single-digit growth, maintaining robust margins and prudent leverage, Veralto (VLTO) actively pursues mergers and acquisitions to fortify its portfolio through strategic capital investment. Positioned as a promising candidate for sustained growth, Veralto (VLTO) potentially sets the stage for a bifurcation (spinoff) of its two divisions, foretelling a potential stock price doubling within one to two years.
- Within its Water Quality domain, Veralto (VLTO) noted a 3.4% growth to $782 million in 4QFY23 from $756 million in 4QFY22, with core sales escalating by 2.1%. The full-year 2023 witnessed an ascent to $3,039 million from $2,887 million in FY22, showcasing a 5.3% growth, with core sales surging by 5.1%. Despite persistent sluggishness in China, management remains sanguine about a rebound, signaling a likely stabilization of the market. Conversely, North America and Europe exhibit steadfast demand across various sectors.
- The Product Quality Innovation (PQI) segment saw a 2.9% uptick to $506 million in 4QFY23 from $492 million in 4QFY22, with core sales growth at 1.1%. The annual figures for 2023 hovered around $1,982 million compared to $1,983 million in FY22, encountering a slight decline in core sales by 1.1%. PQI confronts challenges in consumer packaging demand, offset by gains in marking & coding, countervailing declines in packaging & color areas.
As of 4QFY23, total debt approximates ~$2.6 billion, juxtaposed with a cash balance of $762 million, translating to a net debt of $1.9 billion. Considering the adjusted EBITDA of $1.2 billion, net leverage rests close to 1.54x. Moreover, a robust free cash flow conversion surpassing 100% is poised to solidify their balance sheet, diminishing leverage further.
For Q1 FY24E, management guides a flat core sales growth with an adjusted operating margin ranging between 23.0% and 23.5%. Anticipating low-single-digit growth from the core business for the full year 2024E, coupled with an enhancement of 50–75 basis points in operating margin, Veralto (VLTO) envisages a favorable progression. This margin improvement accounts for incremental standalone costs and other corporate expenditures totaling ~$100 million. Simultaneously, free cash flow conversion is earmarked at ~100%.
Despite the projected stability in Q1 FY24E, a gradual recovery is anticipated following rising costs. I maintain confidence in management’s pledge to secure modest single-digit growth, especially with an anticipated demand resurgence in H2 FY24 for Product Quality Innovation (PQI), all while preserving robust margins and prudent leverage. Furthermore, Veralto’s focus on M&A pursuits propels strategic portfolio enhancement and value creation, positioning Veralto (VLTO) as a robust investment avenue for those seeking enduring gains and strategic growth prospects.
