Buy-recommendation of FLIR Systems’ stocks: fundamental and technical rationale

Key Points of Vision

1. FLIR Systems’ Inc. is a leader among companies produced high-tech thermal and sensor systems and instrument for different spheres and customers (both professional and personal use).

The company’s main growth drivers are:

· Creating and applying of new technologies

· Decreasing of operating expenses

· Spreading of operating and investment activity

2. The fundamental valuation based on multiples’ and DCF-model’s estimation shows that the company is undervalued at least on 15% by multiples’ calculations and 30% by DCF-estimations. In our opinion, the main reason for this mispricing is slow reaction of main market gamers on such good fundamental opportunity of stock-price rising.

3. The Financial year to year performance of the company is really very nice because of stable rate of proceeds’ growth. The main weakness nowadays is negative dynamic if Y2015Q1 to Y2016Q1 net earnings. Also there is negative Brexit’s effect on current price movements. But we predict that future quarters’ results will cover this fact and make the situation much better for sure investments.

4. The tech analysis of FLIR, by the way, was a little bit spoiled by last results of Britain’s referendum. But we believe that fundamental factors and the company’s intrinsic power will prove our vision on future stock-price increase. The comprehensive analysis below confirms this thesis.

Main part of Investment research

Description of the company

FLIR Systems Inc. is a world leader in the design manufacture and marketing of sensor systems that enhance perception and awareness.

FLIR’s advanced thermal imaging and threat detection systems are used for a wide variety of imaging thermography and security applications including airborne and ground-based surveillance condition monitoring research and development manufacturing process control search and rescue drug interdiction navigation transportation safety border and maritime patrol environmental monitoring and chemical biological radiological nuclear and explosives (CBRNE) detection.

The company operates the business through six operating segments:

· The Surveillance segment (solutions for military, law enforcement, public safety, government)

· The Instruments segment (solutions for industrial, commercial and scientific applications).

· The OEM and Emerging Markets segment

· The Maritime segment develops (solutions for recreational and commercial maritime market)

· The Security segment (commercial critical infrastructure and home security)

· The Detection segment.

Latest fundamentally important news and events

In April-May, 2016 FLIR Systems. Inc. (NASDAQ: FLIR) announced the launch of 4 new technologies and products:

1. the FLIR TrafiOne traffic sensor developed specifically for accurate traffic detection utilizing the world’s most advanced low-cost thermal imaging technology.

2. Boson™ is smallest, lightest and least power-consuming high-performance uncooled thermal camera for original equipment manufacturers (OEMs).

3. A range of thermal imaging solutions for firefighters including the FLIR K33 and FLIR K53 handheld cameras the FLIR KF6 camera for fire engines and two FLIR Aerial First Responder Kits featuring the DJI Zenmuse XT powered by FLIR.

4. the FLIR DM284 is an all-in-one digital multimeter equipped with a built-in thermal imager powered by FLIR’s Lepton(R) thermal micro-camera core.

Our opinion is that these new high-tech products will reduce costs of operating activity and potentially will cause increase in revenue and net earnings of the company, consequently it will be a good catalyst of stock-price rising.

At the end of April the company announced financial results for the first quarter ended March 31. 2016. First quarter 2016 revenue was $379.5 million up 10% compared to first quarter 2015 revenue of $344.5 million. On a constant currency basis first quarter 2016 revenue was up 12% versus the prior year. Operating income in the first quarter was $57.4 million compared to $65.8 million in the first quarter of 2015. Profitability in comparison to the prior year was negatively impacted by product mix shifts, higher production costs and unusually low corporate expenses in the prior year.

First quarter 2016 net income was $1.1 million or $0.01 per diluted share compared with net income of $47.9 million or $0.34 per diluted share in the first quarter a year ago. Net income in the first quarter of 2016 was negatively impacted by the recording of $40 million of tax reserves related primarily to the previously disclosed ongoing dispute between the European Commission and the Belgium government over certain tax legislation. Excluding the tax reserve expense earnings per diluted share were $0.30. Cash provided by operations in the first quarter was $44.9 million.

Despite negative Q1 to Q1 results we sure that next quarters of current FY will cover negative dynamics and with the help of new products raise revenue and net earnings and diminish costs.

At the beginning of June the company announced it has priced a public offering of $425 million aggregate principal amount of 3.125% notes due June 15. 2021. FLIR expects to receive net proceeds of approximately $421 million after deducting underwriting discounts and estimated offering expenses. The proceeds from the sale of the notes are expected to be used to prepay existing $250 million principal amount notes that are due September 1. 2016 and for general corporate purposes which may include funding for working capital investments in or extensions of credit to our subsidiaries capital expenditures acquisitions and stock repurchases. The offering is expected to close on June 10. 2016.

It is a good signal for investors (also according to Capital structure’s signal theory) because it allows to look at the company as at the dynamic developing business besides Moody’s Investors Service has assigned a Baa3 rating (investing rating) to the planned five year.

Resuming actual events, there are 2 main conclusions:

· new technologies will provide the company with lower costs and will force the interest of potential consumers and clients. This allows to increase revenue and profit of the company;

· besides aims of new debt. the company is going to use significant part of note’s income to investing and operating activities. It is told about company’s ability to develop its technologies and products.

Peer Analysis

Accumulated market capitalization of Scientific & Technical instruments is 62.04B. The capitalization of FLIR Systems Inc. (NASDAQ: FLIR) is 4.35B. (06/22/2016). Therefore market share of the company is 7.01%

Companies in this industry manufacture instruments that are used primarily for laboratory analysis of chemical or physical properties. Major companies include Mettler-Toledo International, PerkinElmer, and Thermo Fisher Scientific (all based in the US) along with Eppendorf (Germany). Oxford Instruments (UK). and JEOL and Shimadzu (Japan).

Demand is driven by spending on laboratory analysis services, scientific research and other end-user markets. The profitability of individual companies depends on controlling manufacturing costs and maintaining continuous rapid product innovation cycles. Large companies enjoy economies of scale in sourcing material components and product distribution. Small companies can compete by specializing in instruments for niche markets or by developing a reputation for high-quality products. The US industry is highly concentrated: the largest 50 companies account for about 80% of revenue.

Major products include chromatographic instruments, mass spectrometers, pH meters and thermal analysis systems. Companies in this industry may also produce software used for data collection and analysis, as well as pipettes, reagents and other laboratory consumables. These products are used to analyze the chemical or physical properties of various materials or compounds.

Table 1. Financial and market metrics’ comparison of FLIR with its competitors of the industry (based on Yahoo Finance data. 06/22/2016)

The Table 1 shows that FLIR hasn’t dominant position among direct competitors within the industry by financial results and market metrics and multiplies. But financial and some market values are higher than average results in the Scientific & Technical Instruments industry. It is a good factor that the company is not outsider but at the same time is not locomotive of the industry. This fact allows us to conclude that there is a lot of space and opportunities to the company’s development and there is a good potential to the future comprehensive growth.

Financial analysis

Our financial analysis starts from considering of key financial results of the company’s activity. The analysis uses retrospective data of financial statements of FLIR Systems. Inc. The Table 2 below shows absolute and relative differences of profits of the company.

Table 2. Dynamic of proceeds Y2011-Y2015

As we can see from Table 2 there is stable increasing revenue (excepting 2011–2012 period). The same situation is with Gross profit. Also look at total operating expenses: there are relatively stable decreasing figures which show a good performance of operating management in the company. Net earnings of FY2015 were the highest of last five year period. Despite diminishing in FY2013 the company saved capacity to create and to raise their profits. “Relation to total sales” and “Growth rate” graphs also confirm that FLIR Systems. Inc. gained year to year and developed its position and performance.

The next Table 3 describes main changes in balance sheet of the company’s statement.

Table 3. Dynamic of Assets and Capital Y2011–2015

Mainly there are raising Total assets (It is normal and even necessarily for companies of Scientific & Technical instruments industry) and Current liabilities (because of deferred payments). It is pretty thing that Long-term debt was diminishing last five years and reached very good comparable minimum figure in FY2015. It allows us to conclude about high-level solvency of FLIR Systems. Inc. Total shareholders’ equity represents almost direct enhancing trend which proves the company’s capability to create added value of stockholders’ equity and to increase main financial component of equity — retained earnings. This allows us to speak about good investment power of FLIR Systems. Inc.

Table 4. Dynamic of profitability Y2011–2015

Table 4 correlates with dynamics of previous tables and main conclusions. The five-year minimum of profitability is FY2013. The obvious reason is diminishing in Net profit of the company. But nowadays major trend is further qualitative and quantitative growth of profits and the company’s performance and statements.

Valuation

In this paragraph we made valuation of the fair value of FLIR’s stock prices based on two main valuating approaches: multiplies’ and DCF-model’s estimation. The valuation will show our assumption about undervaluation of FLIR Systems. Inc.

Multiplies

The market capitalization of FLIR Systems. Inc. (NASDAQ: FLIR) is 4.350M. (06/22/2016)

To estimate average figure according to calculations we adjust resulting fair values (according to appropriate multiplies) and gave them all equal 20% weight. That was made because of statistic power and all used in the calculation multiplies. Our assumption about undervalued price of FLIR’s stock confirmed fully by 4 of 5 multiplies.

In our opinion, the multiple valuation shows very short difference between current stock-price and expected fair value of our assumption. This is the main reason why we continued the valuation with DCF-model’s approach.

DCF-Valuation

The DCF-model is based on classical adjustments of EV, WACC, FCF etc. and comparable peer analysis. The used data is based mainly on Yahoo Finance source, Reuters, Finviz and financial statements of the company. The calculations, short description and results are below.

First of all we made inputs for our DCF-model based on actual market data on 06/26/2016 and on FY financial reports of FLIR Systems Inc. Different adjustments for calculating EV were made with using data from K-10 report FY2015. The calculation of effective tax rate is based on relation of paid taxes to pre-tax earnings. We estimate average for 3 years figure of effective tax rate.

With support of available data provided by Yahoo Finance we made comparable analysis of companies-competitors. After study and applying financial and market data of competitors the estimation of its EV/EBITDA was provided. We apply statistics’ methods to figure out valuate EV/EBITDA multiple which is actual for FLIR Systems Inc. The multiple was mainly used to estimate Terminal Value of the company.

To figure out WACC and its components we applied 2 approaches: comparable (based on data of companies-competitors) and historical (based on classic concept of CAPM-model and average-weighted market figures of costs of capital). As risk-free rate we apply Daily 20-year Treasury rate of U.S. Treasury bills. Equity risk premium was taken from A. Damadaran published data of countries’ risk premiums. Interest rate on debt was figured out as effective rate e.g. relation of interests’ expenditures to total debt. Other estimations are common and resulting WACC includes the higher of two costs of equity figures.

The DCF-model completed with comprehensive forecasts of different financial metrics (Reuters and Yahoo finance data)and assumptions. Terminal Growth Rate according to Gordon-model and classic formula was estimated as average mean of last 5 years ROE*Reinvesting rate. The resulting FCF and EBITDA were applied to valuate Present Value of the company, Terminal value and Enterprise value. After adjustments the Equity Value and Implied Share Price was estimated

The main conclusion:

· Undervaluation of FLIR stocks proved (at least 10$ or ≈33% of potential stock-price increase)

· There is a serious reason to look at the company as a company with intrinsic potential of future stock-price growth.

Technical Analysis

As we see, there is a strong but volatile long-trend which was started in November-December Y2015.

There are two main price breakouts (green and bold) of inclined levels of resistance.

Before Brexit there was formation of long-deltas and strengthening of future long-trend.

But the results of Brexit referendum and high Beta of FLIR (0.79) made the stock to react as the whole American market, fully fundamental reaction.

We see that last two days there are down-bars with high volume on “Brexit”-bar.

But our forecast is that the price won’t break the strong inclined (bold) level of support and will turn around with long-trend formation.

Our vision is:

· To buy FLIR after turning out at the price 28.50–29.50

· Stop-loss 27.50 is connected with strong horizontal level of support 28.00 (-00.50 from the price-level as an assumption of price trading diapason.

· The target-price near 40.00 is determined with the help of DCF-model and fundamental factors of the future company’s growth (new products and technologies recently announced and new debt for operational and investing aims).

Risks

The main risks of nowadays’ FLIR market position is market risk expressed by Beta. The positive Beta which is closed to 0.79 is not good factor. We show the high correlation of FLIR’s stock-price down-movement and S&P 500 movement which was reasoned by results of Brexit’s referendum and overbought American market.

We tried to connect fundamental risk-factors mentioned above and tech analysis and estimated stop-loss of potential trade as 27.50

Conclusions

FLIR Systems Inc. NASDAQ: FLIR is a world leader in the design, manufacture, and marketing of sensor systems that enhance perception and awareness with good potential of stock-price rising based on:

· the company’s industry (Scientific & Technical instruments).

· activity (products based on thermal imaging).

· ability to improvement (by creating and developing new thermal and sensitivity technologies and products);

· fundamental facts and events (new tech and additional debt-capital rising for operating activity);

· multiplies’ valuation which shows undervaluation of the company;

· DCF-model’s valuation shows sufficient undervalue

· tech analysis (prove of long-vision);

· acceptable risks with asymmetric risk-return ratio;

All these factors and facts allow us to make trading long-term recommendation to buy NASDAQ:FLIR stocks.