Having a large installed base helps NDSN generate strong and consistent free cash flow and provides numerous opportunities for growth as customers’ needs change. For example, a nonwoven customer might introduce a new type of diaper that more closely resembles clothing and requires different manufacturing techniques. As a result, they might need to order a new solution from NDSN, providing growth opportunities for the company. NDSN’s installed base also provides substantial recurring revenue in the form of parts and consumables.
Nordson Corporation (NASDAQ:NDSN) is continuously investing in innovation to stay at the forefront of technological change for its customers. The company invests 2-3% of its sales in R&D each year and has nearly 1,800 global patents in addition to more than 100 years of application know-how.
Acquisitions have further strengthened NDSN’s business model. The company acquires businesses that provide new technologies, sales channels, adjacent markets, and sources of recurring revenue to help it maintain the broadest suite of dispensing, test & inspection, and surface treatment technologies in its markets.
Like many other high quality industrial businesses, NDSN has its own continuous improvement program called the Nordson Business System (NBS). Rooted in Lean Six Sigma methodologies, NBS seeks to deliver on a set of key performance indicators around things such as growth, price effectiveness, cost reduction, productivity, and more to meet the company’s goals.
This type of organizational discipline can be especially effective during periods of slower growth because it can help cushion profits and create stronger operating leverage whenever growth recovers. Most recently, NDSN believes it margin enhancement initiative can deliver a 200 basis point improvement in normalized operating margin by 2017. Whenever global GDP growth begins to improve, NDSN will be in excellent position to deliver strong profits.
Overall, NDSN’s sticky relationships with customers, diversified end markets, solid base of recurring revenue, global service capabilities, concentration in a slow-changing market, and commitment to innovation and operational excellence form the foundation of a strong economic moat.
Key Risks
The primary risks faced by NDSN are temporary in nature. While the business has meaningful exposure to stable consumer non-durable end markets (39% of sales) and generates over 40% of its revenue from recurring parts and consumables sales, it is also exposed to cyclical markets such as electronics and automotive vehicles.
Some of these markets are experiencing temporary weakness, which is hurting NDSN’s volume growth. Furthermore, NDSN is being hurt by the stronger dollar because roughly 70% of its sales take place outside of the U.S.
These macroeconomic factors are suppressing the company’s growth and profitability, but we expect NDSN’s overall market to be much larger in 10 years than it is today.
What could impair NDSN’s long-term outlook? A fundamental change in the manufacturing processes used in the company’s largest end markets could reduce the need for the NDSN’s systems. If viable economic substitutes for adhesives are discovered or products advance to require much less adhesive, NDSN could experience lower demand.
However, we view this as a very low probability event. Adhesives have been in use for hundreds of years and are seeing even more applications for them emerge because they are increasingly lighter and stronger in weight than bolts, screws, and other fasteners.
New competition is also a risk, but NDSN’s long-standing customer relationships and massive installed base are difficult to overcome. For now, we maintain a favorable long-term outlook on the company’s moat.
