FLIR Systems (FLIR, Financial), a company that manufactures sensing technologies (like infrared imaging solutions), reported first quarter results for fiscal 2019 on Wednesday.
For the quarter, revenues increased 1% to $445 million. This reflects strength in the Industrial (up 5%) and Government & Defense (up 9%) segments, offset by a 16% year-over-year (YoY) decline in Commercial revenues (excluding the impact from the divestiture of the retail security business and currency headwinds, Commercial declined by 4%). It’s worth noting that the U.S. Government business, which accounted for nearly one-third of FLIR’s revenues in the quarter, was up by 15%.
While the pace of overall growth was relatively tepid in the first quarter, there are signs for optimism as we look ahead. For example, bookings increased 34% in the first quarter, with the backlog climbing 19% to $836 million. Bookings growth and a strong book-to-bill ratio is what supports management’s confidence that they can meet their 2019 top-line growth targets (8% - 10% revenue growth, with roughly half from organic growth).
Adjusted gross profit increased 7%, with gross margins climbing 270 basis points (to 53.2%). The margin improvement was attributable to favorable product mix and productivity gains, particularly in the Industrial segment (by the way, this was the company’s highest quarterly gross margin for FLIR in over five years). Much of the improvement in gross margin flowed through to income statement, with operating income (EBIT) up 11% YoY to $97 million (margins expanded 190 basis points to 21.9%).
There were 137 million diluted shares outstanding at quarter end, a decline of roughly 3% over the past year. In the first quarter, FLIR repurchased roughly 500,000 shares at a cost of $25 million (roughly $50 per share); in 2018, the company repurchased roughly 5 million shares at a cost of $244 million (implies an average price of roughly $49 per share).
Adjusted net income increased to $73 million, with adjusted earnings per share (EPS) up 10%. The gap between EBIT growth (up 11%) and adjusted net income growth (up 7%) is explained by higher net interest expense and higher other expenses.
FLIR has made some notable deals this year, including the acquisition of Aeryon Labs in January (for $200 million) and the acquisition of Endeavor Robotics in February (for $385 million). While this adds some business lines with compelling long-term growth opportunities, the deals will be dilutive to earnings in the short-term (a roughly 6-cent headwind to earnings per share in 2019). Just to be clear, I have no problem with that: The attractiveness of a deal should not be judged on whether it’s immediately accretive to earnings.
For the year, management expects adjusted EPS (inclusive of the Aeryon and Endeavor dilution) to increase roughly 6% to around $2.35 per share. At $51 per share, the stock trades at roughly 22x forward.
Considering what the company has reported over the past few years, most notably 6% organic revenue growth in 2018 and the expectation for 5% organic revenue growth in 2019, I think it’s reasonable to assume mid-single digit top-line growth in the years ahead (over the past five years, reported revenues have increased at a roughly 4% CAGR). If you also assume some slight margin expansion and continued repurchases, the company can likely earn $3.5 per share in five years. For what it’s worth, this is roughly in line with the long-term targets management has put on the table (with upside from additional M&A). With a 9% discount rate and a trailing terminal multiple in the low-20s, I get to a current price target around $50 per share. That’s a long way of saying that today’s valuation seems reasonable.
Beyond the numbers, I like the vision that CEO Jim Cannon has put forward (in his words, “deploying sensors, and ultimately solutions, that help people make good decisions”). In addition, the strong results delivered in the quarter give me confidence that FLIR can deliver operationally on the objectives laid out at the 2018 Investor Day event. Finally, I like that management is getting more aggressive with the balance sheet and has made some material bets in unmanned applications with Aeryon and Endeavor, in addition to organic opportunities in areas like ADAS (Cannon thinks “it might be the largest single opportunity for FLIR over the next decade”).
I’ve owned a small stake in FLIR for a few years. That probably won’t change at current levels – but if the stock sold off another 15% or 20%, I’d be buying more.
Disclosure: Long FLIR.
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