Saturday, September 29, 2007

Nordson and High Quality Capital Goods Companies

Today's Barrons highlights Nordson Corporation (NDSN) as an attractive capital goods company. I agree that this is a wonderful business at a fairly attractive price.

The article describes the company's global positioning with some 70% of its sales from overseas, yet the gloom that many investors feel about a slowing in the U.S. economy is yet to be evident in Nordson's results. Here is a quote from their third quarter 10-Q:

"On a geographic basis, third quarter sales volume was up in all regions, influenced by acquisitions and higher Industrial Coating and Automotive Systems segment sales. Volume was up 32.1% in the Americas, 15.2% in Japan, 10.8% in the U.S., 9.9% in Asia Pacific and 8.6% in Europe."
In a recent Wall Street Transcript interview of June 11th (subscription required,) Charles Brady of BMO Capital is quite positive on the capital goods space:

"We are still fairly bullish for the industrial space for the remainder of 2007, as well as going into 2008, particularly for some of the smaller mid-cap companies. That is really our area of focus, as these companies often have a much nichier, growthier focus in some of their product lines and geographic areas. In addition, the acquisition pipeline for some of the small and mid-tier companies still remains robust, and there are a number of deals out there that are going to add to the organic growth rates."
Let's have a closer look at this business.

As per the 10-K, NDSN produces precision dispensing equipment that applies adhesives, sealants and coatings to a range of consumer and industrial products during manufacturing operations. The Company also produces technology-based systems for curing and surface treatment processes, as well as life sciences applications. Its products are used around the world in the appliance, automotive, bookbinding, container, converting, electronics, food and beverage, furniture, life sciences, medical, metal finishing, non-wovens, packaging, semiconductor and other industries. Nordson markets its products in the United States and 57 other countries. It operates in three business segments: adhesive dispensing systems, advanced technology systems, and finishing and coating systems.

Here is a spreadsheet the last decade of cash flows for Nordson.

As the Barrons article indicates, the operating cash flow has exceeded net income throughout the decade. From my analysis, about $880 million in CFFO was used to add only about $167 million in capex and about $350 million in acquisitions over this period. Shareholders also shared in the wealth with $172 million in dividends and buybacks (net of share issuance) of $73 million.The five year dividend growth rate is fairly low at 3.65%.

Looking at the financial ratios, NDSN has also demonstrated considerable improvement over the years. Here is some ratio analysis of NDSN per

As one can see, normalized ROIC has steadily improved to 20.8% from low to mid single digit levels. In fact, the last time ROIC peaked at 20%+ was in 2000. The business back in 2000 was still quite global with over 50% of revenues generated outside of the U.S. versus today's 70%. But productivity enhancements have also been established, the business has about 10% fewer employees with revenues up about 20% over that period. Clearly, growth has shifted to Asia-Pacific opportunities as well. And that dollar weakness! The euro has appreciated some 63% since the year 2000.

There are some competitors to Nordson that I believe should be considered as well. Actuant (ATU), Graco (GGG), and Donaldson (DCI) are all interesting niche businesses in miscellaneous capital goods.

Here is a spreadsheet comparison of these companies which looks at the operating profitability, and the cash flow characteristics of these businesses. It is based on their trailing twelve month statistics as provided by As you can see, the companies vary widely.

The real standout in terms of its profitability is Graco (GGG). Its operating margin of 27.24% compares exceeds those of NDSN at 15.38% and the others.Pre tax ROA of almost 44% dwarfs that of NDSN, at 13.35%.

Graco's core competency is manufacturing. Some 30% of its sales come from Europe and the Far East. As per the 10-K, the development of technologically superior, multiple-featured, reliable products is a key strategy of Graco with a particular emphasis on a goal of generating 30% of annual sales from products introduced in the prior three years.

Here are some of Charles Brady's thoughts on Graco per TWST:

"Last year, they (GGG) acquired a company called Lubriquip from IDEX Corporation (IEX) that they are in the process of integrating, and we believe the integration is ahead of schedule. It is a company that has margins well below the Graco average of the mid- to high 20s, so the overall corporate margins for Graco have been dragged down by this acquisition. As is typical for Graco, they will take costs out, make some manufacturing changes and get the margins back up to a much higher level. So we've probably got at least two quarters of continued negative impact from the acquisition, but once we get through that, we expect to see a fairly strong pickup in the overall margin, just from the improvement from that acquisition of Lubriquip."
I will be reviewing a number of these companies in the next several posts.

As always, I appreciate your readership.

Disclaimer: I, my family, and clients do not have a current position in any of the securities mentioned in this post.

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