Roper Technologies: Promising Growth Potential Amidst Challenging Market Conditions (ROP)

Thesis

I stay bullish on Roper Technologies, Inc. (NYSE:ROP), given the corporate’s constant software program focus, disciplined historical past of mergers and acquisitions, and the cessation of the divestment program. Despite the difficult market setting, ROP continues to persistently ship robust monetary outcomes and obtain spectacular double-digit money earnings progress whereas skillfully transitioning its portfolio in the direction of asset-light companies with larger ROIC. The firm’s emphasis on asset-light companies within the software program sector serves as a mitigating issue in opposition to issues surrounding ongoing supply-chain challenges and elevated inflation. I preserve a purchase score on the stock and preserve an end-of-year value goal of $499 on the stock based mostly on an assumed ahead PE a number of of 28x utilized to the FY2025 EPS estimate of $17.84.

Post Q1 Outlook

Roper’s first-quarter outcomes exceeded market expectations. The firm carried out nicely by way of income, primarily pushed by its {hardware} companies at Technology Enabled Products (TEP). I consider the optimistic sequential enchancment in recurring software program income is an efficient signal, and administration’s feedback concerning excessive single-digit (HSD) progress in natural software program bookings additional assist this, indicating that the momentum from the fourth quarter carried over into the brand new 12 months, and demand stays robust.

Roper’s Shift to Software Mitigates Industrial-Outlook Concerns

Demand ought to stay optimistic in lots of finish markets for US industrials in 2023, but financial clouds are constructing. I consider vitality markets might keep favorable as capital spending expands, even with some pullback in oil costs. Construction markets are combined, with industries uncovered to US federal-spending applications akin to gear rental and development gear outperforming. Residential developments are very gentle, and nonresidential development progress would possibly mood, affecting HVAC, constructing controls and a few areas {of electrical} elements.

In my view, Roper’s asset-light, software-focused companies assist blunt worries over persistent supply-chain constraints and heightened inflation. As the corporate capitalizes on its diversified portfolio of digital choices, which ought to proceed to increase by way of M&A, it might outperform its friends. Roper’s deliberate divestment of its product companies will restrict cyclical publicity.

Roper Strategy Won’t Change as a ‘Tech’ Company

I do not count on Roper’s technique to shift a lot with its present portfolio of 75% software program and 25% medical and water merchandise. The decentralized enterprise mannequin will stay intact. The firm ought to proceed to hunt belongings with a sexy money return on funding (CRI), excessive recurring income and low asset depth. Product offers aren’t dominated out, however prior to now decade, well-defined standards have favoured software program — consuming over 95% of M&A funds — which I count on to proceed. Though on the company stage, Roper does not strategically search to construct platforms, particular person companies do bolt-on offers to strengthen market place and gas progress. The administration want to allocate extra capital to bolt-on acquisitions, which provide excessive returns owing to synergies.

ROP Substantially Improves Businesses That it Buys

There is a typical investor notion that ROP buys companies and doesn’t enhance them as a result of it doesn’t extract massive ‘value’ synergies, not like many MI corporations are inclined to do with {hardware} offers; nonetheless, there are a number of examples as an instance how that is undoubtedly not the case. Deltek gives an excellent instance of the expansion algorithm at ROP – rising recurring income HSD organically on a constant foundation, vs MSD progress on the time of acquisition in 2016, alongside a ~500bps improve in EBITDA margins. Market share features seem constant – Aderant has not misplaced a single buyer to its largest competitor in recent times, and its share has risen from 31% to 48% in 7 years. At Vertafore (ROP’s largest acquisition in 2020), R&D has moved from $90 million in 2020 to $104 million in 2022, with extra expertise and new capabilities, and there have been a number of bolt-on offers because it was introduced into ROP.

Financial Outlook

Following a multiyear portfolio-optimization effort, I consider Roper is poised for larger natural progress and returns, low cyclicality and elevated cash-flow era. The sale of the remaining industrial items in 2022 positioned the corporate to attain 9% natural progress vs. 3% in 2019 and an EBITDA margin of 40% from 36%. Compound annual gross sales progress in 2019-22 of the software-led Roper was 14% vs 5% when it owned the economic items. The volatility of annual natural progress narrows considerably with the brand new gross sales combine closely weighted to software program (75% of gross sales).

I consider Roper’s robust cash-flow conversion, averaging 115% prior to now three years, is sustainable. Negative internet working capital, as a proportion of gross sales, improved to minus 17%, with extra to return as larger deferred software program income helps fund an lively M&A technique.

Valuation

I consider Roper ought to be in comparison with a expertise peer group, with software program comprising 75% of gross sales and anticipated to go larger. The sale of remaining industrial items makes it tough to check the corporate to industrial friends. A predilection for software program is the results of a long-standing technique: compound money stream, increase the soundness and sturdiness of money stream and scale back asset depth. Constellation Software Inc. (OTCPK:CNSWF) has an identical roll-up technique but sometimes buys quite a few, very small companies. Constellation’s shift towards searching for bigger offers should not restrict Roper’s M&A alternatives, given an ever-expanding pipeline of area of interest software program belongings.

The stock trades round its common 30% historic premium on P/E, and I believe a cleaner portfolio and visual progress higher assist the premium right here, particularly if the earnings setting will get uneven for others. I preserve a purchase score on the stock and preserve an end-of-year value goal of $499 on the stock based mostly on an assumed ahead PE a number of of 28x utilized to the FY2025 EPS estimate of $17.84.

Final Thoughts

ROP has continued to outperform the market and posted robust monetary outcomes amidst a difficult macro setting. The transition in the direction of a software-led enterprise has been fruitful for Roper, with a compound annual gross sales progress fee of 14% from 2019 to 2022. The firm’s shift to a software-heavy gross sales combine, constituting 75% of complete gross sales, has considerably decreased the volatility of annual natural progress. Moreover, I consider the corporate’s emphasis on asset-light companies within the software program sector serves as a mitigating issue in opposition to issues surrounding ongoing supply-chain challenges and elevated inflation. I preserve a purchase score on the stock and preserve an end-of-year value goal of $499 on the stock based mostly on an assumed ahead PE a number of of 28x utilized to the FY2025 EPS estimate of $17.84.