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The Science of Hitting
The Science of Hitting
Articles (623) 

FLIR: Likely to Buy Again

Some thoughts on the company's 2019 financial results

March 04, 2020 | About:

FLIR Systems (NASDAQ:FLIR) recently reported results for the fourth quarter of fiscal 2019.

Generally speaking, it was a disappointing end to the year. While revenues increased 9% in 2019 due to the contribution of recent acquisitions, they declined 1.5% on an organic basis. As shown below, organic revenue growth at FLIR has trended in the wrong direction over the past 18 months.

Recent results reflect a significant negative impact from the company’s Commercial business segment, which reported a 10% decline in revenues in the fourth quarter. As CEO Jim Cannon noted on the third quarter conference call, “several product lines… continue to face headwinds and some key end markets served [by the Commercial segment] were negatively impacted by geopolitical and macroeconomic factors.” Those headwinds, along with FLIR-specific issues, persisted in the fourth quarter, with the company announcing several strategic changes to refocus the segment’s efforts going forward. (For what it's worth, Commercial accounted for less than 10% of earnings in 2019.)

It was also a difficult quarter for the Government & Defense business segment, with revenue growth entirely attributable to the inclusion of recent acquisitions (Aeryon Labs and Endeavor Robotics). On an organic basis, segment revenues declined 2% in the fourth quarter. In addition, as discussed in the recently filed annual report, the business faces some headwinds over the next 12-24 months:

“In 2019 we successfully wrapped up several large multi-year programs that provided solid revenue contributions over the past several years. While we have successfully won significant new programs, these new programs require investments in R&D and compliance to be successful, and investments in these programs will not directly translate into corresponding revenue until late 2021 and beyond.”

While the pace of organic revenue growth in 2019 was well below management's expectations (as outlined at the 2018 Investor Day event), I think there's reason to believe it will prove temporary. This ultimately depends on the contribution from recent (and continued) franchise wins in the Government & Defense business, along with long-term opportunities in areas like ADAS and UAS.

Finally, the Industrial segment reported a 3% increase in revenues in 2019, with a double digit increase in segment operating income driving a 240 basis point increase in operating margins.

Collectively, FLIR reported adjusted earnings of $305 million in full fiscal, a low-single digit decline from 2018 (revenue growth was offset by margin contraction). Non-GAAP earnings per share was flat at $3.20 per share, with the difference from net income explained by a lower share count.

Over the past five years, cash flow from operations totaled $1.6 billion. Over the same period, the company spent $560 million on repurchases, $390 million on dividends, $220 million on capital expenditures and $1.1 billion on acquisitions (with $600 million in 2019 alone). The net result has been a cash draw of nearly $700 million. This is why the company has seen its balance sheet move from a sizable net cash position to net debt of $375 million at year end 2019. Clearly, this outsized spending will not be sustainable in the years ahead, and I think the progression of repurchases in 2019, as outlined in the 10-K, shows that the company recognizes this reality.

Conclusion

I’ve owned shares of FLIR since May 2012. I have not added or sold since. Over that period, the investment has had decent absolute returns. Inclusive of reinvested dividends, it has generated compounded returns of 10% per annum. But despite that outcome, I’d say that the company’s results have underperformed my expectations over the past eight years. That was most apparent in 2019, and it explains why the forward price-earnings multiple has contracted as of late.

That said, while the 2020 fears are warranted, I still think there’s reason to be optimistic about the company’s future. I think lackluster organic revenue growth in the near term will be an aberration. I like the vision that CEO Jim Cannon has put forward: “deploying sensors, and ultimately solutions, that help people make good decisions." The acquisitions they’ve completed in areas like unmanned applications could be material for the business over the long run.

As I wrote in November, I did not think the stock was cheap enough at ~$53 per share to justify adding. Since that time, the stock has come under pressure and now trades at ~$41 per share. This is the kind of price action that I’ve been waiting for. While 2020 will be a tough year, I think that's account for in the valuation. Said differently, I think this is a reasonable opportunity for long-term investors. That’s why, for the first time in years, it's likely I will add to my position in the near future.

Disclosure: Long FLIR

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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