Teledyne: Shares Attractive Now As Growth Returns (NYSE:TDY)

In Q3 2022, we covered Teledyne (NYSE:TDY). Teledyne is a perfectly run company, but at the time I thought the stock was overvalued while its growth prospects were mediocre. Since then, the share price has risen only 8.6%, while the outlook now looks much better.

Teledyne was founded by Dr. Henry Singleton, unknown to some, but one of the famous capital allocators. And this is reflected in the share price, which has grown at a CAGR of 16% over the past 10 years, outperforming the S&P 500 by 3% per year. Returns over the past 5 years have been moderate, while the S&P 500 is in a strong bull rally. In my opinion, part of this is due to the high valuation of the stock.

Dr. Henry Singleton’s philosophy resonates with me and many other investors. Many of the items on the list are often obvious, but good execution is also part of the successful plan. Dr. Henry Singleton consistently implemented the strategy and built Teledyne into a $5.6 billion annual revenue company.

Now that the stock price has seen little movement and the company has continued to grow, I’m giving it new coverage.

Margin improvement for 2024 and future growth

Teledyne’s strong growth is driven by organic growth as well as acquisitions. The sales market has changed considerably in recent years, and Teledyne now primarily provides sensors and equipment for digital imaging (54% of total revenue).

This carries little risk, however, as the diversification of sales markets within Digital Imaging is very good. Within Digital Imaging, Teledyne supplies the healthcare, defense, aerospace, semiconductor and more industries. Over 22% of revenue is contracted by the US government. Teledyne recently won a $114 million order for the Domain 1 design, development, demonstration and integration contract from the US Army Space and Missile Defense Command.

On a consolidated basis, Teledyne reported revenue of $1.37 billion in the second quarter, down 3.5% from a year earlier. Adjusted earnings per share also fell slightly to $3.77 (down 2.6% year-over-year). This was primarily due to difficulties in the industrial automation and electronic test and measurement markets. Strong growth in the defense market of FLIR and space-based infrared imaging partially offset this. Order intake is outstripping revenue and the backlog is at a record high. This allows Teledyne to achieve stable annual revenue growth. For the full year 2024, adjusted EPS is expected to be between $19.25 and $19.45, which is up about 5% from last year.

FCF also rose to a record high last quarter ($301 million compared to $163 million in 2023). Teledyne took advantage of this by paying down debt, financing acquisitions and buying back its own stock. With more than $1.2 billion in credit facilities outstanding, Teledyne has the ability to make larger acquisitions or repurchase its own stock.

For the rest of 2024, Teledyne is weighing whether it makes financial sense to make acquisitions or buy back its own stock. It depends on the stock price level. Teledyne wants to find the right balance in capital allocation.

With the growth of the digital imaging segment and the acquisition of FLIR, the EBITDA margin also increased significantly to nearly 24%. This is strong growth, as in 2002 the EBITDA margin was only 8%. For the coming quarters, profit margins will improve even more. I quote:

We think for the full year in instruments, for example, they should be up about 90 to 100 basis points. It is quite healthy for us. It will go from what it was last year at 26.6% to 27.5% plus. In digital imaging, we think margins for the year may be down a little bit, even though we mentioned the headwind we have there. But if you look at the entire portfolio while margins have declined in our DALSA 2B business, they have increased significantly in our FLIR business. So we think it could be down modestly, maybe 30 basis points for the year, maybe 20. Aerospace and defense, I think we’re doing very well, maybe over 100 basis points and engineered systems, which is our smallest segment , I think the margins will go down primarily because of the first innings. And overall, we think segment margins should be about 14, 15 basis points higher than last year given all the headwinds that we have. It’s pretty good.

Just one concern

Teledyne depends heavily on new technologies to stay ahead of the competition. Therefore, the research and development department is very important.

Spending on research and development has increased significantly in recent years. By 2010, R&D spending was only 4% of revenue. It then rose to a peak of 8% in 2016, only to stabilize around 6% shortly thereafter.

In the first half of 2024, R&D spending fell below 6%. This increases profits, but I see this as a worrying trend if it continues. If too little priority is given to research and development, Teledyne could become less innovative, which could result in the loss of customers. So I will be watching this trend closely in the coming quarters.

Teledyne is now an attractive buy

Teledyne’s businesses are so diverse that it is difficult to find a comparable company. One possible company is Swedish Hexagon AB (OTCPK:HXGBY). Hexagon also specializes in imaginary equipment and is also growing strongly in both revenue and profit.

For both companies, the share price has been declining since 2022. And that’s not surprising, because the valuation has been expensive. Teledyne’s average 10-year EV/EBITDA ratio is about 17 times higher. This puts the stock in line with the average at the moment. As Teledyne’s sales and earnings are expected to grow, now is an attractive time to enter. The price/earnings ratio shows that Teledyne is undervalued based on 10-year history; the underestimation is about 17%.

For Hexagon, the average 10-year EV/EBITDA ratio is 22. So Hexagon is about 16% undervalued compared to the average.

Conclusion

Teledyne has proven itself for many years. The company has grown significantly into a large enterprise specializing in the development and supply of equipment and imaging. And even now, the company does not seem to stop growing. Teledyne continues to grow on both the top and bottom lines.

Teledyne’s business activities and markets are very diverse, making the company well diversified. As a result, it is difficult to find a comparable company that offers a variety of Teledyne products. However, Teledyne derives the vast majority of its sales from Digital Imaging. As a result, profit margins skyrocketed. And Teledyne expects profit margins to increase further this year.

In recent years, the share price has remained at the same level. And that’s a good thing. Because the valuation is much better now than it was in 2022. We are now at the inflection point where growth and valuation are attractively positioned. Now we can say that the valuation is in line and we can start buying the stock.

Editor’s Note: This article discusses one or more securities that are not traded on a major US exchange. Please be aware of the risks associated with these stocks.