Bruker: Economic Principles Indicate Dislocation To Market Expectations (NASDAQ:BRKR)

Investment update

In May this year, I published a report on Bruker Corporation (NASDAQ:BRKR), titled “Fundamental, Market Generated Data Corroborate Buy Thesis”, reiterating the company as a buy in the process.

Since then, there have been multiple investment updates. Notwithstanding the travel of the broad market in H2 FY’23, BRKR itself has sold off ~20% to the downside since the May publication. Based on this, investors likely expect a combination of (i) tighter market conditions, (ii) less productive business for corporates in FY’24-’25, and (iii) compressed growth for BRKR itself.

This report will focus on the latest investment updates for BRKR and illustrate the potential dislocation in market expectations vs. economic realities for the company over the coming periods. In short:

(i). BRKR appears undervalued when considering its economic characteristics, competitive positioning and market fundamentals,

(ii). However, technicals are not supportive at this point in time, likely related to broad market structure and other macro-level risks, which cannot be overlooked.

(iii). At current multiples, the market has priced a relatively high degree of risk into the stock price, and requires >30% rate of return to bid BRKR higher at the time of writing.

(iv). Despite this, valuations based on the company’s economic performance are in fact supportive, warranting a long-term view.

In that vein, it comes down to one’s investment goals, time horizon, and portfolio setup. In my opinion, this is not a name to be considered for short-term investors, but a holding that could offer compelling value over a very long-term horizon (coming 5 years, say).

Net-net, I rate BRKR a buy explicitly on a long-term horizon, with no expectation of a rapid run up in share price over the coming 12 months, but capital appreciation over an extended horizon of 5-10 years.

Figure 1. BRKR trading back in line with ’22 range

Macro backdrop

Several macro-level factors must be factored into the investment debate here, each with relevance to BRKR’s investment outlook.

One, the S&P 500 index has nudged below its 200DMA, after a difficult month of trading. Critically, the ‘magnificent 7’ market leaders are due to report Q3 numbers this week, and this will shape up the market for the remainder of the year in my opinion. But the fact the US equity benchmark has broken its long-term moving average is remarkable. So a pivot to the upside from here would be something to take note of.

Two, more relevant to BRKR’s distribution business, shipping costs appear to be cooling and now rest back in line with longer-term range, as seen in Figure 1a. The Freightos Baltic Index tracks global container freight rates and is widely used as a benchmark in the industry. So this is an important sign, one that could be a tailwind for those with exposure to global markets.

Figure 1a.

Three, there is ongoing debate about the ‘landing’ the U.S. economy will have with respect to its economic outlook. Will we enter a recession? Will the global economy enter a recession? These are critical questions to ponder. Those at MRB partners have raised interesting points in a recent note. The firm measures the cost of capital as a composite of relevant measures, and says the “cost of capital that may finally begin to meaningfully curb economic activity in the U.S. and aggregate G7 is still decisively higher than current levels”, meaning that “policy rates are still not restrictive”. Rather, they are currently less supportive, as seen in Figure 1b. Interestingly enough, MRB posits that certain weak links could have a contagion effect on global markets, rather than a strong U.S. and Eurozone outlook. “Investors need to monitor these weak links closely”, it says.

Figure 1b.

Critical facts for the reiterated buy thesis

1. Price implied expectations

The market has a high required rate of return on BRKR in order to pile capital towards the company’s market value. At a market value of $8.75Bn and 3.04x sales multiple, investors expect $2.88Bn in revenues this year, ~14% YoY growth (Figure 2). Note, management expects $2.85-$2.9Bn at the top this year. From FY’23-’25, consensus expects an average sales growth rate of 8-9%, which is reasonable to extend out to FY’28 in my opinion. Trading at 17.2x forward EBIT, the market also expects $508mm pre-tax this year, 11.4% YoY growth.

It is also priced at 3.76x EV/invested capital, indicating a high valuation on the firm’s business capital. Comparing its returns on capital deployed of 23%(discussed later) to our 12% internal required rate of return, shows a ratio of 1.92x. So current multiples may reflect earnings power + asset factors well. The market expects a 6.1% forward ROIC from the company (1/(13.76×0.231) = 6.1%). It therefore expects BRKR to reinvest 54% or $273mm of its pre-tax income back into the business this year (RI = ROIC/g). The market implies BRKR to compound its intrinsic value at ~3.2% by yearend on these values.

2. Economic realities vs. market-implied expectations

BRKR is a high-beta name that has high monthly correlations to the S&P 500 index, as seen below (Figure 3). It is no surprise therefore to see the sharp selloff with respect to the broad selloff at the index level. This should be heavily factored in as 1) it could see a further selloff in the short-term, and 2) a sharp reversal if/when the broad market catches a bid.

Figure 3.

The other fact we can’t ignore is that BRKR is creating economic value for its shareholders. Despite the selloff in recent times, the returns the company is producing on capital required to run the business is a standout:

1. $17.10/share of investment produced $3.94/share in trailing NOPAT in Q2, otherwise 23% return on investment. This has ascended each period since 2020. Over that time, it has reinvested $2.95/share to produce $1.59/share in additional earnings, or 54% return on incremental capital.
2. This is a reasonably high-margin, high capital turnover business. Post-tax margins have advanced from 18% in 2020 to 21.3% in the TTM, whilst it turned over capital 1.08x last period as well.

This squares off with the economics of the business well. It implies manufacturing profits are sound, and that inventories are pushed out the door at a reasonable-and sustainable-pace. Comparing to our 12% hurdle rate, BRKR has surpassed this with headroom. Since 2020, it has created ~$15/share in economic earnings above this rate, averaging 9-10% of sales since then. Yet, the share price has rallied just $5/share since December 2020.

As to the economic realities going forward, recent capital allocations provide terrific insight:

(1). In the last 3 years, BRKR has grown sales at a 3.2% compounding rate each period, on stable operating margins of 28%.

(2). This growth accompanied a $0.50 investment for each $1 in new sales, the bulk of which ($0.33) was dedicated to M&A, with $0.08 to fixed capital. It managed to reduce its NWC intensity by $0.01 on the dollar in this time.

(3). BRKR is arguably, therefore, buying its growth via acquisitions. Not uncommon in a company of this size and maturity.

Should it continue at this steady state of operations, the following insights are to be expected:

• It could produce $3.1Bn in FY’24 sales, $785mm in pre-tax earnings, $580mm post-tax, both higher than the market’s expectations.
• It would reinvest $45-$50mm per quarter into maintenance and growth operations, assuming the same rate of M&A ($180-$200mm annnualized). This is in-line with the market’s view.
• It could throw off $518-$587mm in cash to its shareholders (excluding dividends + buybacks) and return 22-23% on its invested capital. This is well above the market’s expectations.

In my opinion, BRKR could outpace the market’s expectations on growth and returns on capital, which supports a long-term view.

3. Technical considerations

Critically, technicals are not supportive of BRKR re-rating in the short-term, which I would define as the coming 3-6 months.

Consider the following:

(1). Profiling BRKR’s price distribution + time at price from Q1-Q3 this year, you can see a double distribution correlating to the pullback in market value.

(2). Markets tend to move from areas of high usage to low usage, hence there is evidence that BRKR could trade lower to fill the lower distribution shown. Equally, it could trade into the $60s for the same reason as well, but not likely above this range in my view.

This activity of distribution is shown in Figures 5 and 5a below.

Figure 5.

Figure 6. Rotated 180º to highlight distribution zones

This notion is supported by the downside targets thrown off in our point and figure studies below. We have downsides to $56 and then $50, indicating the potential for a deeper pullback to these marks. The moves to $64 were eyed well, so I would be looking at these as potential candidates with further downside activity.

Figure 7. Downsides to $56 then $50 plotted on P&F studies

Finally, trend action is equally as unsupportive in the short to mid-term. For instance:

• The daily cloud chart has price and lagging lines below the cloud, requiring a break above $65 to corroborate a bullish view. It looks to the coming weeks, so a neutral view is supported on this frame.
• On the weekly frame (Figure 8) the lagging line is about to test the cloud base as I write. This week’s price action is therefore critical. A break lower would see us push into a bearish zone; a break higher would be something to take note of. This looks to the coming months, so it could be a further push sideways into congestion over this time frame.

Figure 7. Daily cloud chart

Figure 8. Weekly cloud chart

Valuation and conclusion

The stock sells at 23.2x forward earnings and 17.2x forward EBIT at the time of writing. Both are premiums to the sector (29% and 12.6%, respectively). This is an interesting debate we have here.

For one, the multiples are indeed high. There is good research to suggest that 12-month returns are most impacted by multiples paid. The same texts also indicate that, over the long-term (5 years plus), business returns on capital matter most.

In that vein, two points are relevant:

1. Compounding the firm’s intrinsic value at the function of its ROIC and reinvestment rates shows a dislocation in market value to implied intrinsic value, likely a result of BRKR’s high-beta nature (Figure 9). Based on these economics, the company is worth a value of $13.1Bn or $89/share in my opinion.
2. Projecting its steady state numbers from earlier out to FY’28, then discounting at the 12% hurdle rate, gets me to a valuation of ~$10Bn or $65/share, otherwise 19x projected FCF.

Both methodologies are supportive of a buy over the long-term horizon. This I would highly stress in this instance. Multiples are high, but you are buying a quality compounder that offers attractive and sustainable economics, with a value gap of ~49%, above the market’s required rate of return from earlier.

In short, a sharp pullback in BRKR’s market value has opened the funding window for long-term investors to start a position, or allocate to their existing book. I would stress, as mentioned earlier, BRKR is most attractive as a long-term (5-year+) proposition. This is due to:

(i). Multiples are currently high, which could compress 12-month returns,

(ii). But long-term business economics-returns on capital deployed, growth on low rates of reinvestment-support a long-term growth pattern,

(iii). The firm has scope to outpace the market’s implied expectations currently embedded into its stock price.

Collectively, I am looking at BRKR as a buy on these economic principles, eyeing a valuation range of up to $89/share over this horizon, and $65/share in the coming 12-24 months.