Novanta

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Novanta Inc. is a global supplier of core technology solutions that power advanced industrial and medical applications, enabling manufacturers to improve their products’ performance.

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: Novanta operates within specialized, high-growth markets, providing precision motion and laser technology solutions. These solutions are crucial components in the systems of original equipment manufacturers (OEMs) across medical, advanced industrial, and robotics industries. The company designs, develops, manufactures, and sells these components, and their ability to offer customizable, highly integrated solutions sets them apart from commoditized competitors.

Revenue Distribution:

Novanta reports its revenue from three distinct, global business segments:

  • Precision Medicine and Manufacturing: This segment is primarily engaged in the design, manufacturing, and selling of medical and advanced industrial components. Key product areas include lasers for advanced surgical and medical applications, optical components, motion components such as stepper motors and controls, and precision solutions for robotics and automation.
    • The majority of revenues are derived from the medical market, accounting for roughly 60% of overall revenue, while advanced industrial applications generate the rest.
  • Vision: The Vision segment delivers complex imaging systems, high-powered lighting, and advanced image processing technologies. The solutions are used in digital radiology, microscopy, and in other OEM applications.
  • Robotics and Automation: This segment produces advanced motion components that are critical to precision automation, including integrated motors, drivers, controls, and precision encoders. These solutions cater to a broad range of industrial applications with increased demand coming from e-commerce and logistics companies.

Industry Trends:

The industries Novanta serves are experiencing several notable trends:

  • Increased Adoption of Automation: Across various sectors, there is a growing trend toward automation, especially in manufacturing and logistics. This is creating higher demand for motion solutions.
  • Growth of Medical Devices and Technologies: Advances in medical technology, including robotic surgery, diagnostics, and drug discovery, are boosting demand for precision medical components, especially lasers and imaging technologies.
  • Technological Advancements: A continued push to integrate artificial intelligence, machine learning, and robotics into industrial processes is also creating more demand for advanced technologies.
  • Increasing Investments in Global Healthcare: Worldwide healthcare investment is continuing to grow as the need for better diagnostics and more accurate, faster processes of medical equipment becomes more apparent and necessary.
  • Increased Regulatory Requirements: More stringent compliance, inspection, safety and quality requirements, are being implemented in the medical, pharmaceutical and industrial markets that NOVANT supports.

Margins and Profitability:

  • Novanta has consistently maintained strong profitability, which is especially evident in its gross and operating margins.
  • These high margins are a result of its focus on differentiated products, proprietary technology, and the ability to offer high value-add components.
  • Operating profit for the 9 months ending September 30, 2022 was 15.3%, a slight decline over the 15.8% from the same period last year. They cite increases in expenses as a reason for this.
  • The Company also benefits from high levels of recurring revenue, primarily attributable to its after-sales service and maintenance contracts.
  • Net income was $48.3 million in 2021, which was 18.3% of their revenue.

Competitive Landscape:

Novanta operates in competitive markets, however it differentiates itself with several key factors.

  • Specialization and Customization: Novanta focuses on integrating complex and sophisticated, customizable solutions. The company can customize products for particular client needs, leading to sticky customer relationships.
  • Technological Leadership: Through consistent innovation and research, Novanta is able to maintain a significant technological lead in its core segments, particularly in specialized and medical optics, as well as laser technology and robotics.
  • High Switching Costs: Novanta’s customers often rely on their products as a critical component in a complex system. Switching to a new supplier becomes a big headache because of this, which provides customer lock-in and gives a lot more pricing power to Novanta.
  • Established Reputation: A long history of providing quality and reliable components has given Novanta a solid reputation, leading to repeat business and client loyalty.

What Makes Novanta Different?:

  • Proprietary Technologies: They have proprietary expertise in optical and motion control technologies.
  • High R&D Spending: They consistently invest in research and development, driving continued innovations.
  • High Level of Customer Intimacy: Novanta deeply understands the needs of its customer base and tailors solutions accordingly.
  • Global Reach: Their operations span globally and have a strong presence in various key markets.

Financial Analysis:

Revenue:

  • Novanta had a solid revenue growth of +14.2% YoY from $794.4 million to $907.2 million in FY2022.
  • Growth is driven by both organic and acquisitions.
  • They are experiencing growth in all segments, with the fastest growth in the Automation market, due to demand in robotics and logistics.
  • Their performance is fairly stable, with strong sequential growth each quarter, a 10% increase in bookings during the last 3 months of the year is an example.

Margins:

  • They have strong gross and operating margins which are characteristic of high-tech, specialized manufacturing businesses.
  • Gross Profit margin was 48% in 2022 compared to 50.7% in 2021.
  • Operating profit for the year was $141 million, which was 15.5% of revenue.

Balance Sheet:

  • The company has a manageable level of debt, with a debt-to-equity ratio of 0.4 in 2022.
  • Total assets were approximately $1.4 billion and total liabilities are $592 million as of Dec. 31, 2022.
  • They have substantial cash holdings of approximately $115 million, a 16% decrease from last year, but enough to meet operational needs and growth plans.

Cash Flows:

  • The business generates strong free cash flow, which allows the company flexibility in funding reinvestments, acquisitions, and returning capital to shareholders.
  • In 2022, they reported a positive CFO of $174.4 million, almost doubling it from the prior year.

Recent Concerns/Controversies/Problems:

  • Global economic uncertainty: There is a global economic slowdown that could cause a slowdown in their customer markets, reducing the demand for Novanta’s products.
    • Their supply chains may also be hit due to global political tensions. They mention Ukraine-Russia and China-Taiwan as areas of possible disruption.
    • Management notes there is an expectation that the 2023 recession is likely to be milder than first projected and that they are well-positioned.
  • Inflationary pressures: High inflation is driving up costs in both direct costs and operational costs.
    • Management mentions they can pass these costs onto their customers through price increases, but will also continue to search for cost reductions.
  • Increased regulation: Increase in government regulations concerning medical, electronic, and robotic products, means higher R&D costs and the possibility of slower revenue growth due to required product changes.
  • Negative Currency Fluctuations: In 2022, the company saw a $22.4 million negative effect from foreign currency translation, which may affect them again in the future.

Moat Rating: 3 / 5

Justification:

  • Narrow Moat: Novanta possesses a reasonably strong competitive advantage, but the barriers to replication are not insurmountable. The company’s competitive advantages stem from technological differentiation, a solid base of customer loyalty, and network effects through its distribution system. Their economic moats are more reliant on its brand and know-how instead of outright barriers of entry. While those advantages can be defensible, they also come from a place of technological superiority, which can always fade.
    • Intangible Assets: Their brands, patents, and regulatory approval in the medical sector, are defensible, but as those expire and newer technologies come up, they may need to be replaced in order to retain a moat.
  • Switching Costs: The high switching costs to customers are quite substantial, because of high integration with OEM systems, making them reluctant to shift their long-term supplier relationships.
  • Scale: There are scale benefits with manufacturing volume and in their distribution networks, allowing them to get products to customers at low cost.
  • Growth Prospects: They show a consistent and relatively high ROIC that continues to grow, meaning a solid ability to grow value for shareholders.
  • Management: The company appears to have a very stable and competent management team. However, there is no proof of their ability to maneuver a negative macro situation. It is possible that their great results are tied only to a good economic environment.

Legitimate Moat Risks:

  • Technological obsolescence: They are focused in technologically advanced areas, they need to continually focus on R&D to be on the cutting edge, since any disruptive technology could easily destroy its moat.
  • Intensified competition: They are in high-growth markets that attract a lot of new players, which could intensify pricing pressure and reduce profitability.
  • Economic downturns: Negative global economic events can cause a decrease in growth of demand and disrupt their supply chains, severely hurting financials.
  • Changes in regulation: New regulatory changes can require changes in their product line and may require considerable time and money for new approvals.
  • Supply chain disruptions: Because they operate globally, they are vulnerable to supply chain disruptions that could occur due to various global factors, such as trade conflicts or wars.

Business Resilience:

  • Strong Financial Foundation: Their good historical track record, high margins, and strong cash flows provide a solid base of operations and allow to weather any negative economic circumstances, to some extent.
  • Recurring Revenue: Their operations include a high proportion of recurring revenue through maintenance contracts. These provide additional stability during difficult periods.
  • Diverse Customers & End Markets: They work across a variety of industries and end markets. If one of these industries sees a downturn, the rest can support the business.

Understandability Rating: 4 / 5

  • The business model is fairly easy to understand. They mainly make components and solutions for other companies across different end-user markets.
  • Their core value drivers and revenue models are straightforward to understand once you’ve done some research.
  • They do have complex supply chains and technologies behind their products, which takes some time to understand. There are a lot of specialized terms that could take time to learn.

Balance Sheet Health Rating: 4 / 5

  • NOVT has a reasonably strong balance sheet, indicating they can manage debt and leverage without increasing risk.
  • However, there is a decent debt profile that should be monitored. Their D/E (debt to equity) ratio of 0.4 is slightly higher than some of their more conservative peers.
  • They are in a positive trend of improving liquidity and cash flow, but they did use a decent portion of cash in acquisitions.
  • Their liquidity ratio has been slowly improving. This liquidity makes them able to handle potential liabilities and operational stress.
  • Overall, Novanta is financially sound, but needs to monitor their debt levels and growth strategy to ensure it continues long-term stability.