Colfax: Setup Turns Compelling Heading Into The Upcoming Separation Event

Colfax: Setup Turns Compelling Heading Into The Upcoming Separation Event

-----------------------------------------------------------------------------------------

Colfax Corporation (CFX)

Summary

Colfax delivers an impressive quarter across both the FabTech and MedTech business segments.

The Mathys acquisition adds incremental upside to the MedTech earnings trajectory.

With the full-year guidance also raised heading into the planned separation, expect more upside ahead.

-----------------------------------------------------------------------------------

Colfax (CFX), a diversified industrial company involved in the development, manufacturing, and distribution of fabrication technology (FabTech) and medical technology (MedTech) products, recently posted a strong set of quarterly results alongside another MedTech bolt-on acquisition in Mathys. And with the cyclical performance in ESAB also remaining strong at a time when many other industrials are struggling with inflation, the setup into the FQ1 '22 separation looks compelling. As acquisitions continue to pick up across the MedTech portfolio, there remains plenty of scope for incremental upside from additional bolt-ons ahead at reasonable valuations. Assuming management also taps into strategic opportunities around common sales channels or technologies with its M&A, I see investors turning more constructive heading into the FQ1 '22 separation event and, therefore, remain near-term bullish.

A Broad-Based Return to Growth Over Pre-COVID-19 Levels

The FabTech business posted an impressive quarter, growing at a high-single-digit % pace sequentially and by over 45% Y/Y (both on an organic basis). Notably, pricing accelerated during the quarter and provided a c. 11% tailwind (up from the c. 4% in the previous quarter). On the bottom line, FabTech margins also made encouraging progress, ticking higher sequentially to a record 16.4% operating margin. This was a surprise after management had previously guided FQ2 '21 margins down sequentially on cost pressure, which were expected to outweigh ramping volumes. Nonetheless, with pricing actions and volume growth remaining strong, a mid-teens % organic growth looks very achievable through the second half of the year.

On the MedTech side, top-line trends have been strong as well, growing c. 6% relative to pre-COVID-19 levels and c. 60% Y/Y on an organic basis. The Reconstructive business was the key driver, moving up in the double-digit % range relative to prior peak levels – this result was especially impressive considering the industry is still operating below pre-COVID-19 levels. On the back of the revenue performance, margins also bounced back to the low teens %, which should support a continued sequential improvement across both the top-line and margins for the full year as well.

MedTech on the Offensive with Mathys Acquisition

Alongside the quarterly results, Colfax also announced the completion of the Mathys acquisition for a c. $285 million consideration financed by a c. 6.5 million share issuance (implying a $0.03-0.04/share dilution to fiscal 2021 EPS). Management has subsequently sold those shares in an equity offering concurrent with the earnings release. While negative at first glance, the equity offering has allowed CFX to preserve the tax-free status of its separation, which is a modest positive. As things stand, management is projecting a c. $150 million revenue run-rate, implying a transaction multiple of sub-2x EV/Sales on fiscal 2022 numbers. This compares favorably to its MedTech peers, which generally trade at c. 4x, despite Mathys outperforming on the growth front (note Mathys has sustained a double-digit % normalized growth rate).

As a European orthopedics leader focused on the development of innovative products for reconstructive joint replacement, Mathys is an excellent addition to the MedTech portfolio. From a strategic perspective, Mathys is set to significantly expand the addressable market opportunities within the Reconstructive space. Specifically, the acquisition of Mathys will enable expansion into Europe (recall that Colfax's key MedTech asset, DJO Surgical, is over 95% US-based), along with cross-selling synergies via key products such as anatomic shoulder implants. On a pro-forma basis, MedTech's reconstructive business is set to generate c. $0.5 billion in revenue (mainly from DJO and c. 33% from Mathys), with a double-digit % organic growth trajectory supporting a c. $1 billion target over the medium term. I see upside to these targets, however, considering the pipeline of bolt-on M&A opportunities.

Guidance Signals FabTech Improvement Ahead

The near-term earnings growth trajectory looks solid, with CFX raising its full-year EPS guidance to $2.10 - $2.20. While this may seem unsurprising considering the recent earnings beat, it also likely implies underlying operational improvements are outweighing any dilution from the 6.5 million share offering. It is unclear if the Mathys acquisition, which had not yet closed at the time of the guidance announcement, has been incorporated in the guidance, but the fact that CFX still expects FCF generation of over $275 million is a key positive. By segment, management is guiding toward FabTech growing 19-21% organically (including a c. 11%pts favorable tailwind from price), although core EBITDA margins of 20+% will be offset by pricing trends and lower acquisition EBITDA margins of c. 10%.

Looking ahead, FabTech's relative performance should further improve as the business will be able to freely allocate its $450+ million in EBITDA to drive growth in higher-margin verticals and invest in efficiency improvements as well (note that much of the segment's cash had previously been directed towards MedTech). Interestingly, CFX also disclosed that the FabTech business is targeted to operate with initial net leverage of 2.5x-3.0x post-separation, which broadly matches my view that FabTech will take on the majority of CFX consolidated debt going forward.

Final Take

On balance, the modest share price outperformance post-earnings was likely attributable to CFX's acquisition of Mathys, which is projected to add $15-20 million of EBITDA in fiscal 2022. While the decision to finance the deal through equity (rather than debt) seems surprising considering the current interest rate backdrop, there remains plenty of room on the balance sheet for further M&A. And with recent acquisitions significantly boosting Reconstructive revenue on the path toward a c. $1 billion run rate, expect more deals ahead. As such, I see investors turning more constructive on the business ahead of the separation and, therefore, remain optimistic on the shares at the current c. 14x EV/EBITDA valuation.

-------------------------------------------------------------------------------------------

Opal Investment Research, Aug. 15, 2021 

Source

https://seekingalpha.com/article/4449524-colfax-setup-turns-compelling-heading-into-the-upcoming-separation-event