Equity Research Analyst
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Nathan F. Ritz, CFA
Equity Research Analyst
Investment
industry experience since 2008
Nathan
joined Weitz Investment Management in 2011. Prior to joining the firm, Nathan interned
at Moody Aldrich Partners and was a credit analyst at West Gate Bank.
Nathan has a bachelor's in finance, economics and mathematics from the
University of Nebraska-Lincoln.
Excelling as a Specialist of Specialties
IDEX is a multi-industrial engineered products company
that serves niche markets around the world. It supplies specialty pumps, fluid
measurement, metering, fluidics systems, and a host of other specialty products
for an array of industries. IDEX's wide range of products have applications for
industrial, health and science, and fire and safety markets. The common theme
among IDEX's 48 businesses is that they play in niche, highly engineered
applications, where the cost of failure is high.
IDEX is the global #1 or #2 in each of its niche markets,
where the total addressable market is typically under $2 billion. This niche
market strategy gives them the ability to lead on market innovation and pricing
while limiting the threat of new entrants, particularly among well-resourced
mega-caps.
IDEX's products and systems are highly engineered —
meaning the development process is driven by application and process knowledge,
tailored to specifications, and requires extensive engineering work, complex
sub-assemblies, frequent testing, and many individual parts made by IDEX. This
creates upfront involvement with their customers, which allows IDEX to add
value through their world-class commercial organization and, ultimately, to
create a “partnership” structure with high switching costs.
Another of IDEX's notable competitive advantages is that
it competes in mission-critical applications where the cost of failure is high.
Examples include pneumatic pumps and gas compressors used in operating rooms;
ventilators, and nebulizers for hospitals; flowmeters for aviation fuels; high-purity
fluid handling systems for semiconductor production; BAND-IT® clamps used in airbags
and in demanding military, space, and aerospace applications; analytical
instruments and fluidic systems in life sciences and laboratory markets (IDEX has
a leading position in DNA sequencing); and high-precision sealed chemical and
pharmaceutical pumps. IDEX's focus on high-demand applications creates high barriers
to entry for new competitors, establishes sticky customer relationships, and
gives IDEX pricing power and the ability to expand margins over time.
IDEX Operating Model
We have found that companies with differentiated business
systems have compounded value at high rates over long periods of time. A
business system is the combination of core processes, values, and culture that
directs and pulls an organization. As an example, Danaher Corp., another Weitz
holding, has credited Danaher Business System (DBS) as their most valuable
asset and the core driver of their long-term success.
We believe the “IDEX Operating Model” is a similar asset
that differentiates the IDEX organization — particularly through lean
continuous improvement and the deployment of 80/20. The concept of 80/20 is
derived from the Pareto principle, which states that 80% of outcomes or outputs
come from 20% of the causes or inputs. Applied to IDEX's companies — a small
subset of customers, products, and end-market applications have an outsized
impact on growth, profitability, and returns. The IDEX Operating Model directs
the organization's focus and resources to this 20% that has an outsized impact
on long-term returns. IDEX has developed a unique culture and data-driven
companywide processes to segment their markets. This segmentation drives
research and development (R&D), commercial resources, and — importantly —
capital allocation. These processes have kept IDEX focused on critical
technology and value-added components and away from system integration with its
lure of additional revenue.
Lean continuous improvement is the elimination of
non-value-added work and the creation of “flow” throughout the organization.
The combination of lean with 80/20 creates a corporate culture focused on “over
serving” their best customers and markets, while also eliminating non-value-added
complexity that consistently resurfaces in a highly engineered model. Over time,
the IDEX Operating Model has materially increased the quality of IDEX's businesses,
improved organic growth and growth runway, expanded margins, reduced capital
intensity, increased free cash flow generation, and has culminated in a high return
on invested capital (ROIC).
World-Class Management Team
IDEX is led by a talented CEO, Andy Silvernail, who had
his roots at Danaher. True to IDEX form, Andy has focused on two priorities that
he believes can have the largest impact on long-term value creation: 1) building
great teams and unlocking the potential of their people and 2) being good
stewards of capital. We believe these are two of the most important roles for a
CEO.
IDEX operates a highly decentralized organizational
structure. Executive management's role is to provide the environment and tools
for their business units to thrive. Decision making and financial statement
ownership are driven down to the general manager level. This creates an
environment where general managers are incentivized to run the business like it
is their own. Entrepreneurial potential is unleashed, and focus is directed to
the end-customer and users at the front line. The organization becomes more
agile and responsive to market and customer demands. IDEX excels at allowing
the voice of the customer to drive their commercial organization, from product
development and R&D, to aligning their engineering team around solving
customer problems, to expanding their product portfolio into value-added
adjacencies. IDEX's decentralized organizational structure along with extensive
training, talent development, and recruitment programs have led to industry-leading
employee engagement and retention rates.
IDEX's business model generates strong free cash flow,
and management has done a superb job of reallocating capital over time. Acquisitions
have been a core use of capital and IDEX is one of the rare success stories. The
IDEX Operating Model has played a key part in this success, but management has
also put in place guardrails that have increased their “hit rate” on
acquisitions. IDEX is fishing in the right ponds where they are targeting smaller
niche markets ($500mm to $2B) and sourcing proprietary deals. They are looking
to become better, not bigger, which means strategic fit and similar business
characteristics, including highly engineered mission-critical applications, products
that are a small piece of customers' total spend, high switching costs, pricing
power, low capital intensity, and high free cash flow. Finally, management has ROIC
hurdles of 12% by year three of ownership and 15% by year five. Management has
also opportunistically repurchased their own stock when it has offered the
highest return use of capital. They have reduced their share count by 10% over
the past five years.
An All-Terrain Vehicle
Despite some impact to the cyclical pieces of the IDEX portfolio,
we believe the company is well-positioned to thrive coming out of the COVID-19
economic downturn. IDEX has a diversified set of businesses and end-markets
that exhibit resilient pricing and generate strong free cash flow even in
contractionary environments. A long-term-oriented management team and decentralized
organization give IDEX the agility to respond to market conditions and the
ability to continue to invest organically for long-term value creation.
Finally, Andy and his team have been opportunistic, adding value through
acquisitions and share repurchases in the past. With low debt at just 0.7x net
debt-to-EBITDA (earnings before interest, taxes, depreciation and
amortization), there is an opportunity for the company to play offense in an
environment where few others can.
For years, IDEX has been targeted
as an aspirational holding in the Weitz Investment Universe (an ever-evolving
list of companies that fit into our investment methodology and are covered by
our research team). It is a rare investment opportunity where we can check all
the boxes on business quality and moat, management team, corporate culture, and
capital allocation. In March, with the market downturn on the back of COVID-19,
the final piece of the puzzle — valuation — fell into place. For a company that,
in our estimation, can compound free cash flow per share in the low-teens and
generate incremental returns on capital nearing 30%, we were able to initiate
positions in Partners Value, Hickory, and Balanced funds at 19x trailing free cash flow
per share, only a slight premium to the S&P 500 index's 17x. From these levels, we estimate that IDEX is likely to generate a strong internal rate of return over our five-year investment horizon.
/sitefiles/live/documents/AnalystCorner/Analyst Corner_IDEX.pdf
Past performance is not a guarantee of future results. All
investments involve risks, including possible loss of principal.
As of 06/30/2020, each of the following portfolio companies
constituted a portion of the net assets of Balanced Fund, Hickory Fund,
Partners III Opportunity Fund, Partners Value Fund, And Value Fund as follows:
Danaher Corp. (DHR) 1.7%, 0.0%, 0.0%, 0.0%, and 4.3%. IDEX Corp. (IEX) 1.1%, 1.6%,
0.0%, 1.5%, and 0.0%.
Holdings are subject to change and may not be representative
of the Fund's current or future investments.
The opinions expressed are those of Weitz Investment
Management and are not meant as investment advice or to predict or project the
future performance of any investment product. The opinions are current through the publication date, they are subject to change at any time based on market and other
current conditions, and no forecasts can be guaranteed. This commentary is
being provided as a general source of information and is not intended as a
recommendation to purchase, sell, or hold any specific security or to engage in
any investment strategy. Investment decisions should always be made based on an
investor's specific objectives, financial needs, risk tolerance and time
horizon.
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which may be obtained at weitzinvestments.com or from a financial advisor. Please
read the prospectus carefully before investing.
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