Many of you know that we run various “stock sleeves” that we use as S&P 500 tracking replacements – Aptus Compounder (15 high-conviction stocks) and Aptus Core (~50 Stocks) that is composed of both the Aptus Value (25 stocks) and Aptus Growth (25 stocks) portfolios. The intended use of these sleeves is to give single stock exposure to portfolios that does its best to have minimal tracking error to its model replacement, i.e., the S&P 500. With all of these stocks, we provide occasional updates, bull/bear cases, and research reports for clients/advisors to use at their leisure.
So, moving forward, we’d like to highlight one of the Aptus Compounder stocks a month (We did FIS last month). We monitor every stock daily, so we figured that it would be easy for us to transition our notes into a palatable report for everyone.
Compliance Disclosure: Past performance is not indicative of future results. All references to “we/us/our” refer to the views and observations of JD, John Luke, Beckham, and myself.
Roper Technologies, Inc (ROP)
What Do They Do?
Roper operates in niche markets that are generally neglected by technology and insulated from broad competitive threats. At Aptus, we ascribe the value of Roper less to the collection of end markets served and more to the company’s methodology of perpetual capital deployment into asset-light businesses that continually enhance the firm’s cash return on investment (CRI), enable FCF to compound rapidly, and ultimately feed a virtuous cycle of acquired and organic growth.
Roper’s collection of software is mostly in boring verticals (think insurance, power plants, automation, supply chains, and the like). There are some “fun” businesses like 3D animation software in there but mostly it’s stuff in the same “essential but unexciting”.
- Best-in-Class M&A Model – Roper gets a lot of credit for its time-tested M&A model, and we believe that credit is much deserved. Roper has common attributes with private equity firms in that it applies a financial/strategic methodology and consistently acquires companies. Unlike private equity firms, Roper tends to be an acquirer of choice because it: allows current owners to take meaningful cash out, plus Roper runs a decentralized business model, allowing previous owners/founders to maintain its corporate identity and continue to participate in the upside as the business performs.
- Compounding Free Cash Flow is the Magic Elixir – It is hard to call free cash flow a secret, magic, or critical to a business strategy without sounding like Captain Obvious, but we will anyway. Aptus believes the way management thinks about cash flow generation is fairly rare in the public domain. The playbook is straightforward: generate as much cash as possible with minimal assets and roll that cash into acquisitions that fuel further cash generation and feed the virtuous cycle. Seems simple, but we believe the execution has been stellar, and it is exemplified in the company’s financials.
- Investing in Niche Markets Creates a Barrier-of-Entry – A common tenet of the Roper story is its focus on vertical markets or market niches. This focus creates a meaningful barrier to entry, limits the scale and strength of competitive dynamics, and facilitates a positive pricing dynamic in markets with rational competitors.
- Acquisition Model Risks – Roper’s future growth will largely be linked to management’s ability to acquire and successfully integrate new businesses. Roper’s intense acquisition strategy presents risks related to target availability, integration, financing, and target selection. Financing these acquisitions will be dependent on Roper’s ability to generate FCF in the future.
- End-Market Volatility – A portion of Roper’s annual revenue is rooted in industrial (~17%) and energy (~12% oil and gas) markets, which are typically cyclical and reliant on the well-being of local and global economies.
- Price is What you Pay, Value is What you Get – ROP trades at a premium valuation on almost all traditional metrics, most notably P/E and EV/EBITDA. However, when considering the company’s cash conversion, superior margins, and light asset exposure, we believe the premium can be easily justified. The main hurdle for maintaining the premium valuation will be continued M&A execution and balance sheet management – two things management has been doing very well for more than 18 years. Furthermore, given their goal of selling off the lower margin businesses, we could see overall company margins increase – potentially re-rating the company’s valuation higher.
Like it? Nah, We Love ROP:
Roper Technologies is a diversified industrial technology company that provides software and engineered solutions to a diverse and attractive set of end markets including medical, industrial, energy, transportation, food, and other end markets. Its model is predicated on competing in niche markets with an asset-light model to generate gaudy amounts of FCF, which compound over time to feed Roper’s acquisition engine. Our constructive view of ROP is based on shares being catalyzed by accelerating organic growth and effective capital deployment (M&A), which will create strong FCF generation allowing the company to reinvest in high returning projects. We have full faith in the management team to continue executing this strategy at a very high-level.
Last month, Roper announced it will divest its third largest business, TransCore, the leading smart city solutions company, to ST Engineering. The $2.68 billion transaction is expected to close by the end of Q1 ‘22 and represents the largest divestiture in the firm’s history. While we are huge fans of TransCore, we like the transaction from virtually every angle – and it is right in line with our de-lever, deal flow, and divestitures thesis post its recent acquisition of Vertafore.
As a company, Roper is targeting a 50% EBITDA margin from its operations, yet TransCore was pulling in just 24%. Secondly, TransCore had shown minimal organic growth in recent years, whereas some of Roper’s businesses have had decent growth prospects on their own. So, Roper is selling a business that is only half as profitable as its other businesses for a multiple of 20x EBITDA. Currently, Roper is trading around 19x forward EV/EBITDA. The market thinks the business overall, with its focus on software and 50% EBITDA margins is worth around this multiple. Yet, it just sold one of its lower margin, no-growth divisions at 20x EBITDA. Makes you wonder what sort of price Roper could get if it tried to monetize some of its flashier assets. So, even though its current multiple may feel expensive on an absolute basis, maybe it’s undervalued à receiving the conglomerate discount.
Since its 1992 IPO, Roper has grown revenue, EBITDA, and EPS in excess of 20% annually. A mix of internal growth and margin accretive acquisitions has driven revenue and FCF growth. ROP still operates in select cyclical industries, yet the diversification strategy has been a major focus of management (Medical, business applicationsoftware) to ensure solid internal growth, margins and FCF growth through economic cycles and reduce capital intensity. Over the next few years, Wall Street analysts are expecting growth to sustainably be double-digits.
ROP consolidated well over the last 18 months. Late in 2020 and early 2021, it tested supportive fundamental levels ($370 area) as well as LT trend lines (200 and 400 sma’s). $450 was resistance until it broke out decidedly in July ’21. During the Sep-Oct broader market swoon, it fell to its 200 sma for support and also found buyers @ the $450 level again. Support from here should be expected near the $450 level and 200 sma as LT investors buy on LT trends.
Source: Factset, Data as of 12/9/2021
Updated Yield + Growth Framework
Yield + Growth = Total Return
0.53% + 10.50% = 11.03%
Sales Growth + Margin Growth + Inorganic Growth + Repurchases = Growth Rates
9.00% + 1.50% + 0.50% – 0.50% = 10.50%
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward looking statements cannot be guaranteed.
This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.
The company identified above is an example of a holding and is subject to change without notice. The company has been selected to help illustrate the adviser’s investment process. A complete list of holdings is available upon request. This information should not be considered a recommendation to purchase or sell any particular security. The securities identified and described do not represent all of the securities purchased, sold, or recommended for client accounts. It should not be assumed that any of the holdings listed have been or will be profitable, or that investment recommendations or decisions we make in the future will be profitable. Recommendations made in the last 12 months are available upon request.
Advisory services offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2202-14.