Vontier: Promising Growth Potential, But Now Is Not The Time To Buy

Description

I recommend staying on the sidelines for Vontier Corp. (NYSE:VNT). The core thesis revolves around VNT ability to deploy capital to continue its roll-up strategy. I believe VNT can surely pull this strategy off, however, there are near-term headwinds facing the company, including a slowdown in the retail fueling market and the effect from EMV. I think it is best to wait for a better narrative before investing.

Company overview

VNT is a worldwide provider of mission-critical technical hardware, components, software, and services to the industrial sector. VNT’s main offerings include retail fueling equipment, point-of-sale hardware and software, fleet management software, and tools and equipment for repairing vehicles.

Thesis below focus on near-term headwinds and core growth driver in the future. For further description of each business units, please refer to VNT homepage.

Mobile technologies market to grow along with adoption of new technologies

The mobility infrastructure market is vast and quickly evolving due to the widespread implementation of cutting-edge technologies like autonomous vehicles, ubiquitous wireless data networks, and smart city planning. The TAM for all of these industries is, unsurprisingly, enormous. VNT TAM is estimated by management to be worth about $27 billion. The sheer size of the market indicates that VNT can continue to grow, even if this figure is difficult to calculate.

For the industry as a whole, I see several underlying trends that bode well for expansion. Increasing car ownership around the world is the first noticeable development, and it portends well for the industry in the long run. This, along with rising urbanization and a growing global population, poses infrastructure challenges that are partially addressed by the telematics and smart city solutions offered by VNT’s product catalog. In addition to consumer preferences, rising vehicle complexity and a lack of trained mechanics are propelling the search for ground-breaking products and services in the automotive aftermarket. Finally, regulations enacted to ensure drivers’ safety highlight the significance of keeping records and keeping tabs on them.

I believe all these trends are here to stay, and we can already see its impact in our daily lives.

M&A is a huge growth driver

My opinion is that VNT’s long-term potential lies in the management’s ability to deploy capital accretively and drive stronger margin expansion. For the past two decades, VNT has grown by rolling up value accretive companies, beginning with Gilbarco Veeder-Root (GVR) in the early 2000s and including forays into software, emerging markets, fleet management, and transit systems. During this time, VNT has made over a dozen acquisitions, and I anticipate this trend to continue as the company generates strong FCF and working capital pressure normalizes.

In terms of potential expansion opportunities, I see Smart Cities as a promising market in which VNT currently has only a toehold. With a TAM of $8 billion, I believe there will be many expanding markets for automated traffic signals, smart traffic control systems, and public transportation. Another promising new area is electric vehicle charging and related software. In fact, VNT’s purchase of Tritium is evidence that the company’s leadership wants to take part in the expansion of EV chargers. In addition to acquiring Tritium, VNT has also purchased Driivz, an EV charging network software provider. This is a good move, in my opinion, because it gives VNT more opportunities to increase its profit margins in a market already saturated with similar software vendors. All these moves give me great confidence that management has a clear idea on the path to continue its roll-up strategy to grow inorganically and stay relevant.

Last but not least, I think Navman (TN) is undervalued because of the problems that have arisen with the 2017 ELD mandate. There was a lot of churn as a result of 2017, but I think TN360’s release has helped mitigate that.

Near-term headwinds from retail fueling

GVR, the company that makes up the bulk of VNT, has grown substantially in recent years thanks to the adoption of EMV standards in the United States. Since the April 2021 EMV deadline has passed, the replacement cycle has likely been sped up, with about 75% of retail fueling stations having already upgraded to be EMV compliant. Therefore, I anticipate that EMV will be a headwind for VNT over the near term, slowing growth. Specifically, management indicated a sizable drop in EMV-related benefits in FY23 ($300 million). That’s like having a headwind of 10%.

However, this is partially being counteracted by the MT market’s rapid adoption of software for use in convenience stores. The convenience store industry is well established, with annual store count growth of only 1% over the past decade (based on comps data). However mature it is, I believe the largest operators, in an effort to adapt to the digitalization trend, will likely keep spending heavily on software. I expect GVR to ride on this trend and should outgrow the industry (CAPEX growth) because of its size and offerings.

3Q22 earnings’ bad performance is not helping the stock

VNT’s negative 3.0% growth in adj. operating income was below expectations and was caused by slower-than-anticipated growth in MT. This was caused in part by a cybersecurity incident that halted production at a crucial supplier near the end of the quarter. In addition, management has seen a decrease in demand because small independent fueling operators are cutting back on CAPEX as interest rates rise. A revenue headwind of $50 million is expected for the fourth quarter.

The market clearly does not like VNT 3Q22 earnings, as evidenced by the stock’s price action. I think this has caused any long-term investors to sit on the sidelines and wait for things to settle down. If VNT doesn’t start seeing some improvement in its operational results, I expect the stock valuation to remain at the current level for the foreseeable future.

Valuation

I believe VNT is worth USD19.73 in FY23, which is roughly where the stock is trading at today.

VNT will face near-term revenue headwinds from the EMV effect, which will end in FY23, before returning to positive growth in FY24. Earnings are expected to recover and follow a similar trajectory in FY24. As previously stated, the narrative surrounding VNT stock is terrible right now, following 3Q22 earnings, and I don’t see any reason for net new buyers in the stocks for the time being. As a result, I believe valuation will remain at this level at least until VNT shows signs of positive operating results.

Key risks

M&A

A large part of the VNT bull thesis is based on management wisely deploying FCF to conduct value accretive acquisition. While I have complete confidence in their abilities, this increases the risk that an investor is taking – essentially a leap of faith in management judgment. A string of bad acquisitions could harm the stock’s narrative and undermine investors’ trust in management.

Supply chain issue

Ongoing problems with sourcing both labor and materials will lead to higher prices. Since VNT uses a wide variety of raw materials in its production processes, the price of oil and gas also has a direct impact on the company’s freight and utility expenses.

Summary

While the company has demonstrated success in executing its roll-up strategy through capital deployment, there are currently some challenges facing the company, including a slowdown in the retail fueling market and the impact of EMV. It may be more beneficial to wait for a clearer outlook before investing.