Vontier Stock: Street Needs To See A Better Path For Growth

I’ve written in the past that oddly undervalued stocks make me nervous, and Vontier (NYSE:VNT) is at least partly a case in point. Writing about the stock a year ago, I wondered why the shares seemed so cheap, and the shares have fallen another 20% since then despite posting better-than-expected financial results.

While management’s guidance for a quicker decline in EMV-related revenue certainly drove recent weakness, the reality is that Vontier shares have been weak since September of 2021 (the time of the company’s first significant M&A transaction) despite generally good results and a decent outlook. While I can understand some degree of frustration over capital deployment and concerns about near-term growth leverage, expectations are so low now that low single-digit growth can drive a double-digit forward return.

EMV – Sooner Rather Than Later

Providers of above-ground fueling systems, specifically the card readers at gas pumps, like Dover (DOV) and Vontier saw a multiyear boost to their revenue as fuel station owners had to upgrade their payment terminals to accept chip-enabled payment cards or face liability for card fraud.

This process was driven by major card companies like Visa (V) and Mastercard (MA) (EMV stands for “Eurocard Mastercard Visa”) shifting liability for fraud if those new readers weren’t installed, but the upgrade cycle is now largely complete. Headwinds from lower EMV-related sales were already a known risk/issue for Vontier even a year ago, but the timeline for that sales erosion has been significantly accelerated.

While most of the street expected the headwinds to be spread out over several years (through 2025 in some cases), Vontier management announced with fourth quarter earnings that the bulk of the impact ($300M to $350M) would instead hit 2023 results, leading to a significant earnings hole for the company to fill. I had expected a bigger near-term impact in my own model, but still not on this level, and I can understand why investors are now concerned about the near-term “donut hole” in the company’s revenue, margins, and earnings.

Capital Deployment To The Rescue? Probably Not

Adding to the angst, it would seem that a lot of sell-side analysts were disappointed that the company isn’t doing more to patch this gap in the earnings growth progression. Vontier has deployed over $1B into M&A recently, but it won’t add enough earnings to make up for the EMV headwinds. Likewise, management said they would be “opportunistic” with respect to share buybacks, strongly suggesting that they wouldn’t look to restore the EPS outlook by simply buying up shares.

That latter bit, in particular, seemed to really stick in some people’s craw, and the company subsequently announced a $250M accelerated buyback agreement – enough to reduce the share count by about 6% at the time of the announcement.

Personally, I think management is doing the right thing by not panicking over this near-term headwind and deploying capital simply to give the Street a nice clean progression of revenue, margins, and earnings. I understand the real-world impact, the Street is obsessed with short-term revenue growth and margin expansion and punishes the companies that don’t offer enough of it, but I’d rather see Vontier’s management manage the company with their focus on 2025 or 2030 and beyond than 2023 (long term instead of short term, in other words).

Are Recent M&A Decisions A Sign Of Things To Come?

Speaking of capital deployment, I do wonder to what extent Vontier’s recent M&A actions reflect the company’s long-term priorities and vision.

The company acquired DRB in September of 2021 for $956M in cash, paying around 5.6x sales for a company with mid-20%s margins and a likely high single-digit forward growth rate.

DRB is a technology provider to car wash operators, including point-of-sale payment and control systems, software, analytics, and related systems. DRB doesn’t make the hardware that actually cleans cars, but rather the software that handles payments (including loyalty/reward programs), controls the hardware, and analyses customer behavior, as well as creating searchable records for issues like vehicle damage.

This looks like a logical extension of the existing retail fueling business, and it should be accretive to margins.

More recently, Vontier announced the acquisition of full ownership over Driivz, a cloud-based provider to EV charging software (as well as energy management software). Driivz is a “white label” provider, meaning that the company’s software offerings are integrated into other systems, and they help manage EV charging infrastructure, including operations, optimization, and billing. Driivz software works with over 500 different chargers, and I think many customers will appreciate the flexibility and customizability of white-label offerings, versus being forced to go with the attached software from providers like ChargePoint (CHPT).

Given very low revenue today, Driivz isn’t going to contribute positively to earnings, but I see this as another logical extension of the retail fueling business given the future adoption of EV charging. Management also indicated that it intends to deploy $500M or more in capital over the next five years to build additional capabilities related to electrification, alternative fuels (hydrogen included), energy storage, and network management.

Taken together, it would seem like Vontier is looking to follow in Fortive‘s (FTV) footsteps with M&A at least to some extent, acquiring software-based companies with significant recurring revenue streams. That’s not a fundamentally bad plan, but I do hope that management keeps its eye on the ball with respect to the multiples it is paying and the path to double-digit returns on the deals, as Fortive has been getting increasing scrutiny for the multiples it is paying for software deals.

Beyond these deals, I still see opportunities for Vontier to acquire its way into verticals like industrial automation and industrial software, and I also could see more interest in asset tracking and telematics. The turnaround of Teletrac Navman is showing progress, with annual recurring revenue turning positive on a quarterly basis for the first time in quite a while.

The Outlook

Since Vontier outperformed my FY’21 expectations, my FY’21-FY’26 revenue growth falls from about 3.5% to 2.5% despite an FY’26 revenue number that is now about 4% higher. Longer term, my revenue growth estimates work out to only around 1% to 2%.

I actually think these are very conservative numbers relative to the markets Vontier serves, with retail fueling likely to grow at a low-to-mid-single-digit rate, telematics possibly growing at a high single-digit rate depending upon further progress with Teletrac Navman (and industry adoption trends), and tools and wheel service growing at a low single-digit rate.

Admittedly, that’s not an exciting growth outlook, but I do think there are opportunities to drive more growth. I like how Vontier is building out adjacent opportunities to the retail fueling, including convenience store point of sale software and now DRB, and I think telematics could offer more long-term growth. Likewise, I see growth opportunities in attaching more software and service content to existing business offerings (telematics would seem to be an obvious opportunity there).

On the margin side, the steeper near-term EMV headwinds lead me to expect basically flattish EBITDA margins from 2021-2024, with reacceleration thereafter. Admittedly, that’s a long time for margins to be more or less flat, particularly when margins have historically played such an important role in driving valuation multiples.

Longer term, I expect around 2% to 4% FCF growth as FCF margins start expanding in FY’24 and eventually move into the high teens.

While the near-term revenue growth and margin leverage potential aren’t impressive, and neither are the long-term growth rates, discounting those cash flows back still supports a double-digit annualized long-term total return today. Likewise, if I use my lowest estimates for margins and ROIC over the next three years to drive my multiple on through EBITDA, I still get a fair value in the $40s.

The Bottom Line

Clearly, weak revenue growth and weak operating leverage are not an appealing combination today where Vontier’s valuation is concerned. I can likewise understand concerns that the businesses here are not structurally attractive in terms of above-average non-cyclical growth potential. I think that overlooks the cash flow generation capability of those businesses, though, and the opportunity for management to deploy that cash into deals that will accelerate growth and margin leverage. There’s certainly a “leap of faith” element to buying Vontier today, and it could well remain a value trap for some time, but I think the longer-term potential is still appealing.