Updated on February 21st, 2019 by Nathan Parsh
Roper Technologies, Inc. (ROP) increased its dividend by 12.1% on November 12th of last year. In doing so, the company has now raised its dividend payout for 26 years, and as a result it is one of the Dividend Aristocrats.
The Dividend Aristocrats are a select group of 57 stocks in the S&P 500, with 25+ years of consecutive dividend increases.
In order to become a Dividend Aristocrat, a company needs a strong business model, durable competitive advantages, and the ability to withstand global recessions. Clearly, the Dividend Aristocrats are high-quality dividend growth stocks. Being a member of the group is no small accomplishment for Roper.
Even more appealing is Roper’s high dividend growth rate. The dividend has gone up nearly five fold since 2009. The company’s dividend has increased by 17% per year on average during this time.
Even among the Dividend Aristocrats, dividend hikes of 10%+ are rare, which makes Roper’s dividend increases over the last decade very impressive. The company’s current dividend safety is also very reassuring:
This article will discuss Roper’s business, growth potential, and valuation.
Roper designs and develops software, including both software-as-a-service and licensed technology, and engineered products and solutions.
Roper has a diverse portfolio of products and services, which it provides to a multitude of sectors, including healthcare, transportation, food, energy, water, and education.
Roper focuses on four main business segments:
- RF Technology (43% of revenue)
- Medical & Scientific Imaging (29% of revenue)
- Industrial Technology (16% of revenue)
- Energy Systems & Controls (12% of revenue)
The core RF Technology business provides radio frequency identification—or RFID—communication technology, software, and information solutions. This is a booming technology, that has a variety of uses, including toll and traffic systems, security and access control, campus card systems, card readers, and more.
Source: Investor Presentations
The Medical & Scientific Imaging segment offers products and software used in medical applications, and high-performance digital imaging.
Industrial Technology includes water and fluid handling pumps, leak testing equipment, flow measurement and metering equipment, and water meter products.
Lastly, the Energy Systems & Controls segment produces control systems, testing equipment, industrial valves and controls, and inspection and measurement products.
Roper is in the unique position of generating strong growth, across all of its businesses. For example, total revenue increased 11% in 2018. Organic growth improved 8% for the year.
All four operating segments posted revenue growth in that time, led by 15% revenue growth for the Industrial Technology segment. Organic growth for this segment was 14% due to strong demand for products.
RF Technology revenue soared 13% for 2018. Organic growth was 6% for this segment, led by Software Business organic growth of 8%. Network expansion and market share gains aided growth for this segment as well.
Revenues for the Medical & Scientific Imaging segment grew 8%, with organic growth of 7%. Long term care solutions and gains in niche medical applications were the primary drivers of growth.
Energy Systems & Controls grew 9%, with 7% segment organic growth. Upstream applications and broad based industrial end markets helped improve revenues.
Naturally, such strong revenue growth has greatly benefited Roper’s bottom line. The company beat analyst expectations on earnings-per-share and revenue, in all four quarters of 2018. In addition, operating cash flow rose 16% during the year and 27% during the quarter, compared with the same period in the previous year.
Free cash flow increased 19% in 2018.
Source: Investor Presentation
Roper has generated excellent growth over the past several quarters, and its growth should continue moving forward. The company sees earnings-per-share of $12 to $12.40 for 2019. This includes a $0.25 negative impact from Roper’s pending Imaging divestitures.
At the midpoint of this guidance, this is a 3.3% improvement from 2018. Organic growth should be 3% to 5%.
Acquisitions are a key component of Roper’s growth strategy. It spent $8.6 billion on acquisitions, from 2011 to 2016.
Such a high level of acquisitions can be a red flag, if the company paid too high a price for under-performing businesses. But in this case, Roper’s acquisitions clearly built value.
Roper looks for other high-margin companies, with high levels of recurring revenue. The bulk of the spending was focused on RF application software, as well as medical software and services.
Competitive Advantages & Recession Performance
Over the past 15 years, Roper pursued an asset-light business model, with a specific focus on software and engineered products and services. The company adopted this strategy to expand margins, by reducing capital expenditure needs, while also generating recurring revenue. This resulted in much stronger cash conversion over time.
Source: Investor Presentation
For example, Roper generated a total of $1.0 billion of free cash flow, in the five-year period spanning 2003 to 2007. It generated over $4 billion in cumulative free cash flow, from 2013 to 2017. In 2018, free cash flow was nearly $1.4 billion.
In 2018, Roper gross margins improved 90 basis points to 63.5%. Approximately half of total revenue in 2018 was recurring.
This provides Roper with tremendous competitive advantages. Its high margins and operational efficiency provide it with lots of cash flow that can be invested to stay ahead of the competition.
Roper is a cyclical business. It has the capacity for very strong growth when the economy is expanding, but it also struggles during recessions. Earnings-per-share during the Great Recession are shown below:
- 2007 earnings-per-share of $2.68
- 2008 earnings-per-share of $3.06 (15% increase)
- 2009 earnings-per-share of $2.58 (16% decline)
- 2010 earnings-per-share of $3.34 (29% increase)
As you can see, Roper is not a highly recession-resistant company. Earnings-per-share declined 16% in 2009. If the economy were to enter a recession in the years ahead, Roper could see earnings decline.
While Roper’s earnings exhibited volatility, it still grew overall, from 2007 to 2010. As the U.S. recovered from the Great Recession, earnings continued to grow.
Roper has grown earnings-per-share at a rate of 16% annually from 2009 to 2018. Accounting for the likelihood of a steep decline in profitability in the event of a recession, we expect Roper to grow earnings-per-share at a rate of 8% annually through 2024.
Valuation & Expected Returns
Roper is a high-quality company, with strong growth prospects, thanks to the high level of demand for its technology. It should not come as a surprise, that the stock holds a premium valuation. Shares currently trade for a price of $312.
Using the company’s earnings guidance for the current year, Roper trades for a price-to-earnings ratio of 25.6, which is above the S&P 500 Index average of 21.3. It is also significantly above its own valuation over the past 10 years.
Over the past decade, Roper held an average price-to-earnings ratio of 21.7. As a result, the stock is valued at a premium of approximately 18%, to its average price-to-earnings ratio in the past 10 years.
Given that the company is highly susceptible to changes in the economy, we have a target price-to-earnings ratio for 2024 of 19. If shares were to revert to this target valuation, annual returns would be reduced by 5.8% over this time. Potential overvaluation is a risk that investors could consider before buying the stock.
The company is still likely to generate returns moving forward, from earnings growth and dividends. A potential breakdown of future returns is as follows:
- 8% earnings-per-share growth
- 0.6% dividend yield
- 5.8% multiple reversion
In this scenario, total returns would reach 2.8% per year over the next five years.
Roper has a high-quality business model. High single-digit earnings growth is not an unreasonable assumption moving forward. The stock is also a Dividend Aristocrat, and 10%+ annual dividend increases are also possible, thanks to the company’s high earnings growth rate.
However, with a price-to-earnings ratio well above its historical and our target valuation, and a dividend yield below 1%, Roper does not seem to be an attractive purchase for value and income investors at the moment.