Veralto Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Veralto Corporation is a global provider of water quality, product quality, and innovation solutions, focusing on serving customers with diverse technical needs in high-priority sectors for today’s businesses.

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.

Veralto’s business model centers around providing critical products and services that aid in water treatment, product quality control, and related fields. They aim to solve complex, technical problems for their customers which leads to recurring revenue and long-term relations. The company serves customers in a range of industries.

Business Overview

Veralto, a spin-off from Danaher Corporation, operates in two main segments:

  1. Water Quality: This segment focuses on water treatment, purification, and analysis technologies. Veralto provides a range of products and services aimed at ensuring water safety and quality, a rapidly growing market due to increased regulation, demand and concerns regarding limited fresh water supplies, industrial needs, and health. In addition to end consumers they also cater to municipal and other industrial clients. Key offerings include treatment and analysis solutions.
  2. Product Quality & Innovation: This segment caters to industrial and pharmaceutical customers by providing solutions to analyze, improve, and assure their product quality. They have a wide portfolio of products and services related to printing and packaging, coating, labeling, product identification, marking, and inspection.

Veralto strategically targets markets with long-term secular growth, driven by regulatory, sustainability, and product performance trends, that require a high level of technical expertise. The company’s focus on providing essential services and products positions it as an integral component of its customers’ operations. The company works in markets with significant barriers to entry.

Revenue Distribution

Veralto’s revenue streams are geographically diverse, with a significant portion of its revenue coming from North America, Western Europe and other high-growth markets.

  • Water Quality: Predominantly serves North America, Western Europe, Asia Pacific, and Latin America, with a mix of government, municipal, industrial, and residential clients.
  • Product Quality and Innovation: Has a global clientele, with a primary presence in North America and Western Europe. Serving industrial and pharmaceutical markets mostly.

Sales growth has been strong, as detailed in the latest earnings call, with both segments seeing increased revenue.

  • Specifically Water Quality is seeing significant growth, mainly driven by improving pricing and product mix, coupled with higher sales.

The industries Veralto serves are characterized by the following trends:

  • Increasing Water Scarcity: Heightened focus on efficient and effective water treatment and supply systems.
  • Stringent Regulation: Growing need for testing and analysis to ensure product quality.
  • Sustainability Mandates: Demand for efficient solutions to reduce environmental impact.
  • Globalization and supply chain complexity : Increased importance of product tracking, inspection and quality checks.
  • Technological innovation : Demand for continuous innovation and adoption of new digital tech.

Margins

Veralto’s operating profit margins vary by segment but overall, the company maintains a strong double-digit operating margin that suggests a decent pricing power over its offerings.

  • The product quality and innovation segment has been able to maintain higher operating margins than the water quality segment.
  • The cost of sales has risen for the business in the most recent quarterly results, reducing margins, this can be temporary.

Competitive Landscape

Veralto operates in markets with different competitive structures:

  • Water Quality Segment: faces competition from other companies offering similar water treatment, purification and analysis equipment and solutions. * Product Quality and Innovation Segment: is highly competitive with various providers offering similar equipment and services. They compete with both large companies and specialized niche providers.

Veralto’s competitive advantage is mainly through the unique technologies and expertise, brand reputation, long-term relationships with customers, and unique access to distribution channels or a niche market position, which allows them to sustain sales.

What Makes Veralto Different?

  • Wide Moat: Although they offer specialized products, their main moat lies in strong customer relationships stemming from recurring revenue sources, and unique and niche applications where the company is the go to for that specific service. They are not a commodity product but at the same time are not a high innovative tech product. They are somewhere in the middle which makes the moat unique and hard to replicate.
  • High-Value Solutions: Veralto doesn’t just provide products; it offers solutions that solve complex problems, often involving proprietary technologies and methods, that increase customer’s willingness to pay a higher premium.
  • End-to-End Capabilities: From water treatment to product quality control, they provide a complete suite of services, which allows them to increase customer captivity and be in control of the entire value chain for each particular business and product.
  • Strong Market Position: Through its market share and reputation, the company acts as a reliable partner for its clients.

Financials

Recent Financial Highlights (Based on the latest documents):

  • Revenue: Strong increase in revenue, with positive trends in both the Water Quality and Product Quality & Innovation segments.
  • Operating Profit: Remains strong at double digit levels, suggesting good pricing power and efficiency.
  • Earnings Per Share (EPS): Increased compared to last year.
  • Liquidity and Debt: The company has access to debt if required. Although the company currently has low debt levels (only 1% interest bearing debt). The company had an operating cash flow of $681 million as of December 31, 2022 and an ending cash balance of 585M.

Veralto is a consistent business with very strong profitability metrics, and it seems to be getting better YoY. The company is also working on improving its financial position.

Stock-Based Compensation

  • Verlato uses stock-based compensation plans to incentivize employees, which leads to some share dilution.

Accounting Changes

  • They have recently reorganized their earnings report format.

Recent Concerns/Controversies and Management Response

  • There are currently no specific controversies surrounding the company or earnings calls, although the company’s operations have been impacted by the broader economic downturn which seems to be impacting their margins by a bit. Management seems to have good control over these variables.
  • The company is heavily investing in its production capacity and its R&D budget, which is important for its long term growth and competitive advantage, as the company stated in its latest earnings report.

Moat Rating: 3 / 5

Veralto has a narrow moat that is well established but does not have the width of the moats of companies with a very strong brand or technology. Here’s the breakdown:

  • Intangible Assets: Veralto’s moat is in part due to its reputation and established client base. There is some stickiness with existing customers.
  • Switching Costs: High switching costs for some of the industries they serve where the integration with client’s business is very high.
  • Cost Advantages: They provide high value solutions and services to customers, hence their prices are higher, but they do so at a better margin than competitors.
  • Network Effects: Network effects are not a substantial advantage in this business model.
  • Durability: Though it’s hard to replicate their technologies and processes, if another company put in the investment they might be able to challenge them.

Risks To The Moat & Business Resilience

  • Technological Disruption: New technologies or new solutions that emerge may quickly make existing products obsolete. The company is continuing to innovate, however their main advantage is not technology, but rather brand recognition, strong relationships with its clients and its ability to offer value to customers. The risk is therefore lower.
  • Competition: Strong rivalry from existing competitors could lead to price pressures or loss of market share. Their products though are very differentiated and targeted, thus the probability is lower.
  • Economic Downturn: Slowdowns in the broader economy could reduce capital spending of its major clients which can negatively impact Veralto’s demand and sales. However, they are also present in many recession proof markets such as water quality.
  • Regulation: New legislation regarding their activities might impede their business and profitability. However, regulations are also a benefit in some cases (like water industry).
  • Acquisitions: The company has done a few acquisitions lately, and if these are not properly integrated, it could have a negative impact.

Understandability: 3 / 5

Veralto’s business model is moderately complex. Although their main business is in water treatment and product testing, their operations are diversified and sometimes difficult to grasp. The technical aspects of their business also increases complexity.

Balance Sheet Health: 4 / 5

Veralto has a healthy balance sheet with a limited amount of debt and strong levels of liquidity, providing the company with high financial flexibility. The debt-to-equity ratio is low, showcasing low financial risk for the company.

Overall, Veralto is a solid company, that is working hard to improve its financial performance, reduce costs, and become even more profitable in the long run. The company is mostly immune from disruptive technologies and has a narrow but reasonably strong moat.