SweetBunFactory
Nordson (NASDAQ:NDSN) is a precision technology-focused industrial company that has comfortably beaten the S&P 500 over the past decade. Nordson is said to be a high quality company, so let’s see if it can live up to its name and may even present an attractive investment opportunity at current levels.
Nordson outperformance over ten years (Koyfin)
What is Precision Technology?
Precision technology is an indefinite term that generally means that something is precise. Nordson divides its business into three divisions that serve five end markets:
- The Industrial Precision Solutions division represents 51% of revenues and is at the heart of Nordson. The division includes adhesives, industrial coating systems, management and control solutions and polymer processing systems. To summarize, it is mainly about packaging and other processes that take place towards the end of an industrial manufacturing process.
- The Medical Fluid Solutions division represents 27% of sales. The division also focuses on fluid management and other products focused on the storage or transfer of medical equipment.
- The Advanced Technology Solutions division represents 22% of sales. The division includes electronic processing, test and inspection systems.
We see Nordson focusing on machines, parts and consumables for the final stages of industrial manufacturing processes like packaging, testing and inspection. This results in a high percentage of recurring sales (51% of sales are parts and consumables, the remaining 49% are systems sales), the holy grail of any investment. Recurring revenue increases the certainty that a company (and analysts) can predict activity and reduces the need to always sell new products. Ideally, you want to have a lower percentage of system sales, which requires a higher recurring sales rate. Nordson is quite close to this configuration.
In addition, Nordson has a very diverse customer base, spanning five end markets between 12 and 30 percent of total revenue. In the image below you can also get a better picture of Nordson’s various product offerings.
Nordson End Markets (Presentation to Nordson Investors)
Organic growth
Nordson operates in relatively stable industries due to its high recurring revenue mix. In the table below, I have compiled some numbers based on 2022 regarding the different segments (expected growth rates/CAGR are taken from management). For the most part, Nordson does not expect tremendous organic growth in its business and expects organic growth across all of its divisions to be between 3-5% with upside potential. A 3-5% organic growth rate doesn’t excite me, so they either have to trade at high FCF yield or increase their earnings in other ways.
| Revenue | EBITDA margin | Expected CAGR | % of total revenue | |
| Industrial precision | $1337 million | 35% | 3+% | 51% |
| Medical fluids | $690 million | 40% | 5+% | 27% |
| Advanced technology | $563 million | 25% | 5+% | 22% |
Growth through mergers and acquisitions
Due to the lack of organic growth, Nordson occasionally acquires companies to add to its portfolio. Over the past decade, the company has spent a total of $1.66 billion in cash on acquisitions, representing a very modest 12.6% of the free cash flow generated by the company over the same period. period. It is common knowledge that mergers and acquisitions are a risky business for companies, knowing that between 70 and 90% of mergers and acquisitions destroy value. Therefore, a company that makes strategic mergers and acquisitions must demonstrate a good framework and discipline in its approach. I want to see the following aspects of such a strategy:
- A strategic insertion in the business model. This may be to gain market share in existing business lines, to enter adjacent businesses or to create cost synergies. I don’t like to see totally independent companies being acquired; which often backfires due to the lack of existing knowledge in these areas. Nordson addresses this point and points to a portfolio of products within Nordson’s circle of competence and in high-growth end markets.
- Onboarding new businesses is always critical; if two corporate cultures collide, it often leads to failure. Nordson solves this problem by requiring a customer-centric business model, as Nordson did with its Ascend strategy.
- The focus on revenue growth is one of the main factors why most mergers and acquisitions destroy value. That’s why I want the focus to be on the profitability of the business. Nordson takes care of margins and requires at least a 20% EBITDA margin with room for improvement. Moreover, they need the ROIC to be higher than the cost of capital in 3-5 years. This last part is a bit generous, in my opinion, because a good company should always generate returns above its cost of capital.
- Finally, the price paid matters a lot and often contributes significantly to the destruction of value. While Nordson doesn’t explicitly talk about a preferred hurdle rate or multiple for acquisitions, based on the latest additions (medium to high EV/EBITDA), the company appears to be buying around its own multiple. Not great, but it doesn’t seem to be overpriced either.
Nordson M&A Strategy (Nordson Investor Presentation)
The efficiency lever
The final lever the business needs to pull is improving margins, because this is about profit growth, not revenue growth. The graphs below show that gross margins have remained stable at 55%, while profit margins are trending higher. A great metric to track that gets too little attention is SG&A margin, which accounts for the bulk of business costs. We can see that the SG&A margin has gradually decreased from 35% to 29%, which coincides with an increase in profit margins of around 5-6%. The company still has room to increase its margins, but it won’t be too significant. Additionally, we can examine Nordson’s reinvestment efficiency by looking at the gap between ROIC and WACC, which is 8%. We aim for at least 2%; otherwise, the company destroys shareholder value.
Margin profile of Nordson (Koyfin)
A quality business trading above fair value
To value Nordson, I performed an inverse DCF analysis with a required discount rate/rate of return of 10%, a perpetual growth rate of 3%, and the assumption that the number of shares will be reduced by 1% per year through buyouts after the past decade. According to the model, Nordson must increase its FCF by 12% in the first five years and then by 10% in the following five years. Management has guided with a medium-term (20-25) outlook of sales growth of over 7% and EBITDA growth of 10%, so we can assume that FCF should also be around the bar of 10%. At this price, I don’t see great returns to Nordson. The company would need to deploy far more money in M&A than its historic 10% FCF to grow fast enough to justify its stretched valuation.
Nordson Inverse DCF Model (Authors Model)