Fortive

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Fortive Corporation is a diversified industrial technology company that focuses on designing, developing, manufacturing, and servicing professional instrumentation, software, and related products across a variety of industries globally.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Fortive is a diverse, global company operating in the industrial technology space, with a unique approach to growth and value creation. They essentially operate three segments: Intelligent Operating Solutions (IOS), Precision Technologies (PT), and Advanced Healthcare Solutions (AHS). Instead of focusing only on product and service development, it emphasizes what it calls the Fortive Business System (FBS), a process-driven approach to continuous improvement that permeates all aspects of operations.

Revenue Distribution:

  • Intelligent Operating Solutions (IOS): This segment provides connected workflow solutions for industrial automation, and the service and manufacturing industries.
  • Precision Technologies (PT): This segment offers a variety of test and measurement equipment, specialty medical devices, and sensing products.
  • Advanced Healthcare Solutions (AHS): This segment concentrates on providing healthcare, infection prevention, sterile processing, and sterile barrier technologies and services.

Although the reported segment results are separated between these three segments, revenue is derived through various products and services. To understand what drives sales of each product line, one must understand the end user.

Industry Trends

  • Automation and Digitization: Across all three segments, there’s a clear trend toward automation and digitization. Customers seek increasingly integrated solutions that enhance efficiency, reduce costs, and improve safety.
    • In the IOS segment, this involves moving to connected solutions that integrate multiple workflows and enable data collection, analysis, and improved decision making.
    • In the PT segment, there’s a push toward digital transformation in data, communication, and cloud-based solutions.
    • In the AHS segment, we observe a growth in automated processes in infection prevention and sterile processing, reflecting stricter regulations and increased demand for safety.
  • Sustainability and Efficiency: An increasing awareness of sustainability is driving companies to seek ways to operate more efficiently and reduce waste. This often involves the adoption of more efficient solutions in manufacturing and data-driven insights that lead to improved environmental outcomes.
  • Healthcare Advancements: The healthcare sector is under constant flux and growth, which provides ongoing opportunities for companies operating in medical and healthcare technology. The push for innovation is a must for the companies to stay ahead in the market, and there are no signs of slowdown in this sector.
  • Globalization: All the markets in which the company is operating are global, and companies must have local capabilities to support them.
  • Supply Chain Resiliency: Amid recent supply chain problems, companies want increased control over the supply chain and are seeking better methods to streamline manufacturing and production process for resilience and optimization.

Competitive Landscape

  • Fragmented Markets: Across all its sectors, Fortive faces numerous competitors, which are largely fragmented. This is both a challenge and opportunity, as the company has the advantage of economies of scale and scope, and can pursue targeted acquisitions.
  • Variety of Competitors: The landscape includes everything from small, niche players to large conglomerates. A specific business that they have or product that they sell can have completely different competition, and there is no common rival that it has to face in all of the areas in which it operates.
  • Technological Innovation: The tech sector is ever-evolving and requires firms to constantly invest in new and innovative products.

What Makes Fortive Different?

  • Fortive Business System (FBS): Their unique, systematic approach to improving their operations is what sets Fortive apart. It’s process-driven and data-based. The company culture is completely built around it and it permeates all areas and is, according to the management, a sustainable competitive advantage.
  • Diversified Portfolio: Fortive’s diversified portfolio allows it to benefit from various sectors and economies. The wide-spread nature of its products, services, and geographic location protects it from complete disruption and allows it to withstand macro-economic shocks.
  • Strong Balance Sheet: Strong balance sheet enables it to pursue large acquisitions and expand its reach into new sectors.
  • Acquisitions & Roll-ups: They seek out niche companies, acquire them at reasonable prices, and quickly integrate them into the wider organization, thereby generating growth and synergies. This way it can acquire many smaller firms, increase their value, without needing much growth in existing businesses. This allows for an amazing, quick growth in the business.
  • Intangibles: As shown in the last annual report, a significant portion of its capital is in intangible assets such as goodwill, which means a lot of premium is paid for acquisitions, and management intends to create a moat by carefully choosing strategic acquisitions, which is the cornerstone for its business.

Financials

  • Revenue Growth: Fortive has shown solid revenue growth, especially when acquisitions are taken into consideration.
  • Operating Margins: Despite strong revenues, their operating margins have remained quite stable at around 20%. This seems to be the level where most of its businesses are comfortably positioned in this stage of growth. If growth in margin isn’t there, then it must be coming from operational and product improvement.
  • Free Cash Flow: Free cash flow (FCF) is high compared to net income, which indicates solid asset and capital efficiency, which leads to overall strong profitability.
  • Leverage: The company’s total debt is around 3.5 billion. While some of the debt can be attributed to the acquisitions, a large amount of that is also used in R&D and other investments. Debt-to-equity ratio is around 0.3, which is not alarming, implying the company has a strong ability to pay back debt.
  • Return on Invested Capital (ROIC): ROIC has declined somewhat, which could indicate that the returns on acquisitions have been lower, but still quite impressive as ROIC remains around 12%.
  • Strong Cash Flow: The company is generating excess cash from its operations, and they have a very high capability to make dividend payouts, do share buybacks, and pursue future acquisitions. They are not forced to seek out debt to cover cash requirements, a huge plus point.

Moat

Based on the framework discussed in the given source, Fortive possesses several elements that contribute to an economic moat, but with certain caveats.

  • Intangible Assets: The strength of Fortive’s moat lies more in the effectiveness of their operating systems and their ability to acquire companies strategically, rather than intangible assets. They have a few brand names in some segments, but that doesn’t seem to be a major competitive advantage, as it does not translate into pricing power or repeat business. For other segments, such as test and measurement, the business is highly commoditized. The moat in regulatory licenses and patents is also low, so overall the intangible moat seems weak.
  • Switching Costs: In some of their segments, particularly IOS and AHS, the company experiences meaningful switching costs due to the level of business integration between Fortive’s products and customers, thereby creating a lock-in effect. These switching costs are not consistent across all segments, thus only a few segments have moats based on them.
  • Network Effects: Network effects play only a limited role in Fortive’s business. They are present in some segments but the effect is not strong enough to create a wide moat.
  • Cost Advantages: The primary driver for the cost advantage is from their FBS system, which helps them operate more efficiently. This is a solid competitive advantage, but the biggest risk is that other competitors can also emulate this methodology or do one better.

Moat Rating: 3/5 - They possess solid competitive advantages, but they are not as strong and ubiquitous as seen with companies with wide moats.

Moat Risks

  • Technological Obsolescence: Especially in PT and IOS sectors, the rapid pace of technology may render current products obsolete and force the firm to reinvest in innovation to stay afloat.
  • Imitation of Processes: The success of FBS depends on its complexity and being hard to replicate. Should this become easy to replicate for competitors, Fortive’s differentiation would be severely challenged.
  • Integration Risks: Given their focus on acquisitions, Fortive must constantly work to integrate new companies, their processes, and personnel. This poses a huge execution risk, because if the integrations aren’t smooth, there will be losses in profitability, synergy, and time.
  • Maturity of Products: As businesses age and have fewer growth opportunities, their earnings start to plateau. They might have to look for new markets or technologies to expand their moat, which is an incredibly time-consuming process. It is extremely important to understand the life-cycle of a product/business, as the value it gives to a company will change accordingly.

Business Resilience

  • Diversification: The diversified nature of the firm, across multiple sectors and geographies, makes it somewhat resistant to market shocks and downturns.
  • Strong Free Cash Flow: As a highly profitable business, it can easily ride out economic uncertainties, and still have ample resources for acquisitions and other investments.
  • Management’s Emphasis on Long-Term Value: Given the structure and the approach that the company takes, managers will likely make better long-term, strategic decisions that will make the company resilient.

Understandability

Fortive’s business model, while diversified, is centered around industrial technology and a core operating principle, which makes it understandable for a regular, financially literate person. Given that it does not directly compete in high-tech and AI fields makes it relatively simpler to understand. The complex nature of their financials and acquisitions might seem intimidating, but given some level of understanding in accounting, this process also becomes easy.

Understandability Rating: 4/5 - Relatively easy to understand the underlying business. Requires a bit more work and understanding to grasp the financial implications of its acquisitions.

Balance Sheet Health

  • Low Leverage: They do not have an alarming level of debt, and seem to have more than sufficient financial reserves to cover them.
  • High Current Ratio: They are very well positioned to cover their short-term liabilities and obligations.
  • Adequate Current Assets: The ratio of liquid assets is more than one, suggesting a healthy level of liquid assets.

Balance Sheet Health Rating: 4/5 - Good current ratio, low debt, and high free cash flow, are a positive sign. It is a well maintained and managed balance sheet.

Recent Issues and Concerns

  • Supply Chain Issues: In the latest filings, management did acknowledge that the supply chain issues were affecting revenue numbers due to bottlenecks and inability to fulfill customer orders on time. They are confident in resolving these issues in the long term.
  • Inflation: Fortive stated that inflation is impacting their costs. To reduce these cost pressures, the management is focused on better productivity, efficiency, and cost optimization.
  • Recession: Given the nature of its business and products that are heavily tied to global industrial production and manufacturing, this business can also be hit by the recession. Fortive believes it has built a resilient business and can ride out a recession.

Even though the management has addressed and has a strategy in place to overcome the aforementioned challenges, they pose a risk to company’s profitability and growth in short to medium term.

Conclusion

Fortive presents a compelling investment case with its exposure to industrial technology, the potential for long-term growth and strong cash generation. The company is actively taking steps to address any short-term issues related to supply chain and inflation. While the moat is not very strong, the business has many other favorable elements that make the company a sound investment. As with every company, execution by management remains the most important aspect to watch for.