You may notice the word "de-risked" in quotes in this piece -- a term uniquely present only on Ametek's conference calls and barely heard elsewhere in this jargon-filled world of ours. I find this vernacular odd. It is also too commonly used by the analysts who cover this particular company.
My long-term conceptual framework built around Ametek (AME), which makes electronic instruments, has been challenged of late. Long-time Chief Executive Frank Hermance, now executive chairman, retired as CEO in early May, replaced by David Zapico, a long-time executive at the company. The market capitalization under Hermance's tenure as CEO grew from $700 million in 1999 to $11 billion upon retirement. Well done, of course, but is the law of large numbers an issue going forward?
Guidance has been uncharacteristically lowered, and then "de-risked" three times in a row ¿ a situation that long-time Ametek's shareholders are not used to. The company's results are generally extremely reliable ¿ and the recent misses have caused the stock to underperform other mid-cap growth industrials, like Danaher (DHR), IDEX (IEX) and Roper Technologies (ROP). Many of these companies share Ametek's pain from a cyclical perspective, but the others have also been more adept at forecasting variability in near-term results. AME shares are down 15% over the last 12 months, while DHR is up 13%, IEX is up 7% and ROP is down 6%. Again, AME shareholders are not used to this level of underperformance.
Obvious issues in oil and gas capex, about 9% of total revenues, have contributed to these declines in forecasts. Indeed, the larger specialty-metals business, about 13% of revenue and tied to industrial, medical and aerospace spending, has been plagued with choppy demand and excess inventory. Estimates for the back half of 2016 hint that a mix of demand recovery and inventory rationalization will set the stage for earnings growth again in 2017.
I'm not as optimistic. It's going to be a tough slog for Ametek to differentiate itself from here in terms of performance.
It splits its $4 billion in total sales between two large segments, vaguely named the electronic-instruments group and the electromechanical group. The company boasts margins well past 20% and generates solid free cash flow and return on earnings. That has been used prudently for tuck-in acquisitions year after year. It's a solid business for sure, but also already widely recognized by the throngs of growth-starved cyclical types. We need an encore.
To move the needle on both sales and operating income, Ametek needs to make larger acquisitions. Feeding the M&A beast is tougher and more competitive because the valuation multiple on the company has compressed. Growth is also challenging for the types of property the company needs to pursue as they move up the specialization and technology curve.
We will see this coming quarter if AME truly has "de-risked" the year and reset expectations on the core business. The stock may respond favorably if they have -- but the M&A story may need to change if it's going to build on its $11 billion market cap.