By Ryan Fuhrmann, CFA
Teleflex(NYSE: TFX) is sometimes referred to as a poor man’s United Technologies(NYSE: UTX) or General Electric(NYSE: GE). All are considered conglomerates and operate in industrial product markets, but Teleflex is a puny little girly man compared with the other two giants in terms of market capitalization. Its market cap is about $2 billion, while United Tech’s is $61 billion and GE’s is $354 billion. Plus, the two behemoths are both members of the almighty Dow Jones.
I’ve followed Teleflex for quite some time and have used its stock volatility to my advantage, swooping in and picking up some shares near their lows if the situation has warranted. Well, the stock is hovering around $50 as I write this, near a new low for the year. Plus, it was trading at $60 just a week ago. Let’s see what happened and whether this constitutes a buying opportunity.
The reason for the downfall? Management lowered its full-year earnings forecast from a range of $3.91 to $4.12 a share to a range of $3.65 to $3.80. Based on the new guidance, the shares are trading at a forward P/E of 13 to 14. One reason cited for the lower guidance was weakness in the company’s medical segment (33% of 2005 sales), one of three business units that also include commercial (47%) and aerospace (20%). There will also be a number of one-time restructuring charges.
Overall, the reduced guidance is not surprising to those familiar with the company. Its results tend to fluctuate, and it’s also at the tail end of a multiyear restructuring effort to exit unprofitable business lines and improve sales and overall returns. The years 2005 and 2004 included a number of related charges, but things have since improved, as witnessed by a reduction of net debt as a percent of total capital to 26% in 2005 — down from near 40% in 2004, as cash has increased every year since 2003.
Annual sales and earnings growth have been rather weak over the past five years, mainly because of struggles at the commercial segment, which operates primarily in industrial equipment. Aerospace also tends to be more cyclical, whereas medical is the most stable, least cyclical, and fastest growing. However, medical represents the smallest segment of Teleflex and is accounting for the recent weakness, even though it does account for almost half of operating income.
The most compelling reason to own Teleflex is its robust free cash flow generation. The clearest illustration comes from the most recent SEC 10-K filing, which shows that free cash flow has increased every year since 2001 and averaged an impressive 32% annual average growth over the past five years. I estimate 2005 free cash flow per share at $5.54 for a price-to-free cash flow ratio of just over 9, and a free cash flow yield of almost 11% (which is just an inverse of P/FCF). And that’s not considering any growth in free cash flow, referred to as free cash flow total return by legendary Bill Miller of Legg Mason‘s (NYSE: LM) Value Trust.
Employing a two-stage implied cash flow model, I estimate that Teleflex needs to grow only about 3.5% annually for the next 10 years to justify the current stock price. (Major inputs include a 3% terminal growth rate and a 15% discount rate.) If we assume that Teleflex can grow cash flow 5% a year for 10 years, then the stock could be worth as much as 20% more than the current price. This seems very achievable. As with any model, it’s useful to do a sensitivity analysis, but a fair value range closer to $60 appears reasonable — and that’s where the stock traded just last week.
Although the bigger industrial conglomerates are larger and likely more stable companies, I’d go with tiny Teleflex at this point in time.
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