Updated on January 15th, 2020 by Samuel Smith
Roper Technologies, Inc. (ROP) increased its dividend by 10.8% on November 15th of last year. In doing so, the company has now raised its dividend payout for 27 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. We believe the Dividend Aristocrats are among the best long-term investments that can be found in the stock market.
You can download a full list of all Dividend Aristocrats (along with important financial metrics that matter) by clicking on the link below:
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 ~16% 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.
Business Overview
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:
Application Software (29% of revenue) Network Software and Systems (27% of revenue) Measurement and Analytical Solutions (31% of revenue) Process Technologies (12% of revenue)The Application Software business includes Aderant, CBORD, CliniSys, Data Innocations, Deltek, Horizon, IntelliTrans, PowerPlan, Strata, and Sunquest as its main products.
The Network Software and Systems business includes ConstructConnect, DAT, Foundry, Inovonics, iPipeline, iTradeNetwork, Link Logistics, MHA, RF Ideas, SHP, SoftWriters, and TransCore as its main products.
Measurement and Analytical Solutions include Alpha, CIVCO Medical Solutions, CIVCO Radiotherapy, Dynisco, FMI, Gatan, Hansen, Hardy, IPA, Logitech, Neptune, Northern Digital, Struers, Techhnolog, Uson, and Verathon.
Finally, the Process Technologies segment includes AMOT, CCC, Cornell, FTI, Metrix, PAC, Roper Pump, Viatran, and Zetec.
Source: Investor Presentations
Roper has broadly benefited from the steady expansion of the U.S. economy over the past decade. We believe the company can maintain a positive growth trajectory for many years going forward.
Growth Prospects
Roper is in the unique position of generating strong growth across its business. For example, total revenue increased by 4.1% and diluted earnings-per-share improved by 29.8% through the first three quarters of fiscal 2019.
In its third-quarter earnings report Roper revealed that its adjusted gross margins improved by 80 basis points to 64.6% and spent about $1.8 billion to acquire two quality, niche software businesses in iPipeline and ComputerEase. iPipeline is a provider of cloudbased software solutions for the life insurance industry and managemenbt expects iPipeline to contribute roughly $200 million of revenue and $70 million of after-tax free cash flow in 2020.
It also expects the acquisition to be immediately cash accretive and deliver high single-digit organic revenue growth.
Source: Investor Presentation
Acquisitions are a key component of Roper’s growth strategy as it has spent well over $10 billion on acquisitions over the past decade.
Normally, such a high level of acquisitions would be a red flag, since many companies pay too high a price for under-performing businesses. However in this case, Roper’s acquisitions have clearly added value to the company.
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 16 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 and in 2019 it will likely have repeated or exceeded that number.
In 2018, Roper gross margins improved 90 basis points to 63.5%. Approximately half of total revenue in 2018 was recurring. By comparison, in its most recent quarter, margins had improved to 64.6%.
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.
Another competitive advantage that Roper has is that it is highly diversified within the technology sector. It owns 45 independent businesses with leadership positions in niche markets. Furthermore, these end markets are quite diversified and offer strong recurring revenue and customer retention.
Investors should also note that 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 2025.
Valuation & Expected Returns
Roper is a high-quality company, with strong growth prospects, thanks to the high level of demand for its technology. Therefore, it should not come as a surprise that the stock holds a premium valuation, as shares currently trade for a price of $375.
Using the company’s earnings guidance for the current year, Roper trades for a price-to-earnings ratio of 28.8, which is above the S&P 500 Index average of ~22. 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 31% 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 2025 of 19. If shares were to revert to this target valuation, annual returns would be reduced by 8% over this time. Potential overvaluation is a risk that investors should consider before buying the stock.
In our view, contraction of the valuation multiple could essentially negate the company’s earnings-per-share growth over the next five years. A potential breakdown of future returns is as follows:
8% earnings-per-share growth 0.6% dividend yield 8% multiple contractionIn this scenario, total returns would average less than 1% per year over the next five years. This shows the negative potential impact of buying stocks trading well above their historical valuation. A declining valuation multiple can significantly reduce total returns for shareholders, even if earnings-per-share continue to grow.
Final Thoughts
Roper has a high-quality business model and high single-digit earnings-per-share 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.
Roper fits the bill of a great company, but not a great stock to buy at the present time. Again, this is simply due to overvaluation.
With a price-to-earnings ratio well above its historical average and our target level and a dividend yield below 1%, Roper does not seem to be at an attractive purchase price for value and income investors at the moment. Investors should wait for a meaningful pullback before buying the stock.