Most of the investor attention has focused on how companies are set to deal with the coronavirus and/or how they might grow their revenue in a recovery. That makes perfect sense, but there's also an opportunity for businesses with good balance sheets to make growth-enhancing acquisitions during the slowdown. In this context, let's take a look at why Honeywell International (HON 0.85%), Watsco (WSO 0.47%), and Roper Technologies (ROP 2.36%) are stocks that can emerge stronger from the COVID-19 pandemic.
Rock-solid balance sheets
The following chart shows each company's net long-term debt at the end of its most recent quarter and its trailing twelve-month earnings before interest, taxation, depreciation, and amortization (EBITDA). From these numbers, you can calculate the net debt-to-EBITDA ratio -- a figure that indicates how many years it would take a company to generate the EBITDA in order to totally pay off its net debt.
Although there's no consensus over the matter, credit agencies typically regard a ratio of 2.5 times EBITDA as being suitable for investment-grade debt. Fortunately, all three companies have excellent ratios.
Watsco and Roper are business that have been built up through acquisitions, and making them is an integral part of their business models. However, they haven't built up a lot of debt in doing so. Meanwhile, Honeywell's low debt level is indicative of how well the company has been run in the last decade. As such, the management teams of all three companies said they would be interested in making acquisitions or investing significantly in developing their businesses.
Honeywell's exposure to commercial aviation is a concern, but the industrial conglomerate is so much more than just aviation. In fact, commercial aviation contributed less than a quarter of the company's revenue in 2019. The rest of its business portfolio is comprised of companies exposed to industries as diverse as defense and space, refining, building management systems, and raw materials processing.
Although this is going to be a down year for Honeywell, the company has enough exposure to the broader economy that it can grow revenue and earnings in 2021 if the global economy is in growth mode -- even if aviation is slow to come back.
It's also interesting to note that Honeywell's strongest business right now is also one of its most recent acquisitions, namely Intelligrated. The company, bought in 2016 for $1.5 billion, is a provider of supply chain and warehouse automation solutions. As such, it's seeing strong growth from servicing the e-commerce warehousing sector. Furthermore, discussing future merger and acquisition activity on the recent earnings call, Honeywell's CEO said: "I think that this is an area which could be an opportunity in the second half of the year. "
All told, Honeywell is in a position to make acquisitions in 2020.
The heating, ventilation, air-conditioning, and refrigeration (HVACR) distribution company's business model involves buying market share and territorial expansion via acquisitions. It's proven to be a highly successful strategy, and investors have enjoyed a remarkable run in the last couple of decades. Strong revenue and earnings growth has fed through into a startling increase in shareholder value, and the stock currently sports a sustainable-looking 4.5% dividend yield.
CEO Albert Nahmad believes Watsco can carry on consolidating a highly fragmented industry, and he affirmed that he was minded to continue investing for growth even in a downturn. Speaking on Watsco's recent earnings call, he said that "our financial strength allows us to invest during downturns as well as steady markets. We are long-term-orientated, and we have the ability to invest, and we'll continue to invest."
The late Brian Jellison wasn't a household name to most investors, but he should be. Over a 17-year tenure as CEO, he pioneered a business model based on acquiring asset-light businesses with leading positions in niche industries.
As you might imagine with such a strategy, the company tends to be run on a decentralized basis, with capital allocation decisions made centrally. After all, it's hard to see how one central management can run the day-to-day operations of businesses that include industrial pumps, legal and insurance software, traffic management solutions, materials analysis, and radiotherapy solutions. However, Roper's central management can decide on the characteristics of the businesses it buys.
Before you conclude that this is merely business school jargon, just take a look at the chart below.
In order to continue this successful strategy, it's important that Roper take advantage of opportunities in a downturn, and the good news is that CEO Neil Hunn is perfectly prepared to do so. Speaking on the recent earnings call, he said: "We do expect many attractive capital deployment opportunities to arise from the current economic situation. As our balance sheet is very well positioned, we will offensively deploy capital as the right opportunities are identified."
All told, it's reasonable to expect all three of these companies to make acquisitions which could lead them to emerge stronger from the COVID-19 crisis than when they went into it.