EUR 850.00 For Business Accounts Only

Morningstar | After Another Blowout Quarter, We Raise Our FVE by Nearly 3%

Narrow-moat rated Roper Technologies had an exceptional quarter and once again meaningfully outperformed our expectations for the stock. As such, we raise our fair value estimate to $232 per share from $226 previously. Overall organic revenue rose 9% year over year (or 13% year over year on a reported basis), and the company reported double-digit revenue increases across all four of its segments from last year’s third quarter. Even with additional tailwinds from growth fueled by acquisitions, the company still managed to lift both its gross and EBITDA margins by 80 basis points (to 63.8%) and 100 basis points (to 35.8%), respectively. Impressively, free cash flow rose 34% to $404 million, or 31% of revenue, demonstrating the strength of its asset-light business model.

Roper is an exceptional manager of its working capital (the reason for our Exemplary stewardship rating). An appreciable portion of the firm’s business model revolves around software, underscored by its name change to Roper Technologies from Roper Industries in 2015. This allows the firm to build large amounts of deferred revenue, which is typical in software businesses. While GAAP accounting books deferred revenue as a liability, this is incorrect from a business perspective. The firm continually has negative net working capital since software companies get paid up-front, and this deferred revenue buildup is the primary driver of consistent negative net working capital, which allows Roper to continue compounding this upfront cash with other value-accretive opportunities (either through acquisitions or organically). For context, five years ago (end of the 2013 third quarter) deferred revenue constituted about 6% of revenues. Today, as of the end of the third quarter, that number is nearly 12% of revenues, allowing net working capital to total negative 2.2% of end of third quarter 2018 revenue.

Another important component of its business is its niche strategy. Moreover, the company doesn’t compete on scale, but on differentiation based on proximity to its customers. We believe this is manifested quantitatively based on the strength of the firm’s outsize gross margins relative to peers. While the firm runs a decentralized model, which we like, it also has a strong organizational culture based on incentives, and we expect that to continue under new CEO Neil Hunn (who replaces Brian Jellison, who stepped down from running Roper day-to-day due to illness and will remain on as executive chairman).

Finally, the firm raised its adjusted diluted EPS guidance to $11.69-$11.73 (from $11.40 to $11.56 previously), and we raise our estimate to $11.69, at the bottom end of the new range. Highlights from the quarter include Neptune within the firm’s industrial segment, which managed to punch in double-digit top-line growth on continued share gains. On the call, Hunn explained that Neptune (which makes smart meters for water utilities) is seeing multiple customer networks forming on the back of a plan that emphasized backwards compatibility with legacy products years ago (that is, customers don’t want to abandon their historical investment). We continue to expect that the firm’s disciplined formula for M&A will continue rewarding shareholders for years to come.