On March 7, FLIR Systems (FLIR) held its investor day to recap fiscal year 2012 results and discuss the outlook for the business heading into 2013. As you likely know if you’re reading this, I pitched FLIR as a value contest pick back in May (here), and still like the company despite the nice move higher since then. Considering that the investor day was quite long, I’m going to break the presentation up into three articles, in this order: Government Systems, Commercial Systems and Corporate/Financial Overview, along with my closing thoughts.
With that, let’s get started on the Commercial Systems review:
As a refresher, the Commercial Systems division is comprised of two reporting segments: Thermal Vision & Measurement (TVM), and Raymarine. Government collectively accounted for 56% of FLIR’s $1.4 billion in revenue in 2012, with TVM reporting $628 million in revenue (45% of company total), and Raymarine reporting $158 million in revenue (11%). Revenue in the TVM segment declined nearly 5% in 2012, and was a material weight on the company’s financial results; Raymarine struggled as well, due to weak consumer demand for the company’s products – largely attributable to macroeconomic weakness in Europe.
The year 2012 wasn’t easy for Commercial Systems: Backlog decreased for the first time since current division president, Andy Teich, joined the company – 28 years ago. Globally, backlog declined 3%, with a 9% decline in EMEA being the most significant negative contributor (Americas was down 1% and APAC was up 3% – growth, but at a much slower rate than what FLIR’s become accustomed to); overall, revenue fell 5.5%, with EMEA sales down 11% from 2011.
While last year was a bit disappointing, the long term trend in Commercial Systems is well in-tact. In the five years since 2007, Commercial Systems’ volumes and revenues increased at a rate of 27% and 15% per annum, respectively (in-line with management’s vision to lead on volume to drive costs lower and remain well ahead of the competition, something that management considers “critically important”). Over that same frame, here’s how FLIR’s global market share of Commercial Infrared Cameras & Cores changed (in units):
Vertical integration, which has long been a differentiation for FLIR, goes nicely with 40% market share; here’s Mr. Teich on the company’s advantage in this space:
“This is a real strength for FLIR. So we are vertically integrated starting at the very bottom – ROIC is the readout integrated circuit, which is a piece of silicon with a base circuitry for an infrared detector, running all the way on up through vacuum packaging techniques, module packaging, cryogenic coolers for the cooled system, signal processing, lasers, electro-mechanical devices and so forth. And these are very important things. And I think that this is particularly important when you come to a discussion of commoditization. Because people think about, well, commoditization is a detector. And there's a lot more to a detector than just the detector itself. There's a lot of intellectual properties that's embedded in the layers that are shown here which FLIR currently possess.”
Long term, FLIR sees its opportunity as such: “Infrared Everywhere” - “It foresees a time where infrared is part of everyone's everyday life, where we extend human perceptions to include seeing heat variations, seeing in the dark and measuring temperature. If we look at how the strategy is working, well, it's been a successful strategy. We've made good progress towards the goal. We've pioneered and developed the technology significantly over the last ten years, both at the sensor and the camera level. For our products, that technology has advanced our products; to the extent that we sell Cores & Components to our competitors, it's advanced their products; and it's allowed us to develop world-class end use products and distribution for specific verticals in the industrial, professional and, increasingly, consumer markets, which I'll be talking about in greater detail today.”
Automotive continues to be an opportunity for FLIR (first offering in this space only dates back to 2006), where it is the only competitor (100% market share); however, 2012 was the first decline in volumes for the business since 2008 (“tough year for luxury cars”), after a period of serious growth from 2009 to 2011 (volumes more than doubled over that time frame). Due to some issues with specific product lines (namely Audi A8 production, where the line was stalled for part of the year), as well as a misjudgment in regards to Chinese demand (availability in option packages were only to highest-tier, resulting in weaker adoption), volumes ended up coming in at roughly half of FLIR and Autoliv’s (company’s automotive distribution partner) expectations. With that said, 2013 is expected to be much stronger – the company will start having products with a third OEM (Daimler, to go along with BMW & Audi), and expects volumes to roughly double from 2012 levels.
In Thermography (which brings temperature measurements to industrial, commercial, scientific and automation, gas imaging applications, etc.), FLIR continues to lead the industry with a majority share (estimated at 60%); at this point in time, the largest application for the technology is in the building, electrical and mechanical markets.
In Maritime, FLIR comes to market with a dual brand strategy: The FLIR brand is primarily being sold in the law enforcement, work boat and cruise industry, with Raymarine addressing the recreational piece of the business (fishing, sailing, boat manufacturers). As the company’s noted before, its main strategy is to make thermal imaging “as important to boaters as their radars, their sonars and their GPS.” Assuming that the industry continues to grow and that uptake increases (per management’s expectations), there’s little doubt that FLIR should grab a nice piece of the action: The company estimates that FLIR branded thermal holds nearly three-quarters of the addressable market. Looking at the company’s offering in the space is at looking at Procter & Gamble’s (PG) different brands across the laundry detergent business (with the difference being that P&G’s global laundry share is “only” around 30%): FLIR offers six different models across their product ladder in Maritime, ranging from $2,000 to $250,000 or more.
In Security (where FLIR holds roughly one-third of the market), volumes were up materially in 2012; however, a shift in mix (from high-end cooled systems to uncooled systems) resulted in a decline in revenues. This is in line with a longer term trend – uncooled has increasingly outpaced cooled in this space since the mid-2000s. We see a similar product ladder here (from $2,000 to $200,000), giving potential consumers the ability to find the system that meets their needs. A good example of a new consumer in this space is insurance auto auctions; with storage lots with thousands of cars (requiring an area that would be costly/difficult to fence and secure), these sites have dealt with significant theft issues over time. FLIR’s security solutions provides a more practical (and effective) solution than paying guards to walk the endless aisles of vehicles. To date, the company has completed 10 locations (10 to 12 cameras per site); the expected payback on the investment to the lot owner is less than one year.
I mentioned applications in traffic in a recent FLIR article, so I won’t harp on that again; however, I think these comments in regards to the Traficon acquisition are well worth hearing:
“So this acquisition was done in right at the end of the year, and it has 2 main advantages to FLIR. Number one is that it inserts us squarely into the traffic market. We can use their distribution organization, their product development teams to really go after this segment much more so than we have been. And then the second thing is, Traficon is basically a video analytics company. That's fundamentally what they do: video analytics and video analytics processing board. And it will allow us to leverage that technology into other markets like securities and maritime most specifically. And we've already started that activity.”
This statement is in-line with FLIR’s long term strategic vision: category leadership (in volumes) is used to drive lower prices and expand applications of the core technology – a combo that has pushed even further share gains in many segments (as well as opened up new ones), even from dominant starting positions. I see this as a virtuous and sustainable cycle still in its early innings.
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with 2-5 positions accounting for the majority of my equity portfolio. From the perspective of a businessman, I believe this is sufficient diversification.