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HOLD on Ametek (AME) Thursday, March 4, 2010 The University of Scranton Team CFA Society of Philadelphia – Investment Research Challenge Mike Dwier ‘10, Fred Fuchs ‘10, Tom Prokop ‘10, Blaise Schultheis ‘10, John Walker ’10 Thurs 3/4/2010 1 CFA Philly IRC - Scranton Team

CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

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A presentation a group of students from The University of Scranton (including me) made as part of the CFA Institute of Philladelphia Investment Research Challenge.

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Page 1: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 1

HOLD on Ametek (AME)

Thursday, March 4, 2010The University of Scranton Team

CFA Society of Philadelphia – Investment Research ChallengeMike Dwier ‘10, Fred Fuchs ‘10, Tom Prokop ‘10, Blaise Schultheis ‘10, John Walker ’10

Thurs 3/4/2010

Page 2: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

Agenda

Thurs 3/4/2010

1. Highlights of a Hold2. Macroeconomic Forecast3. The Margin

Expansion Story4. Summary

Page 3: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 3

Highlights of a Hold

Valuation Highlights Stock Price History

Thurs 3/4/2010

Target of $37.17 is approximately 7% below current market price $40.1.

Investment 10Yr Annual Return

AME 19.2%

S&P Industrials 1.8%

S&P 500 -0.9%

Quarter Q4 Q1 Q2 Q3 Q4 Full YearYear 2009 2010 2010 2010 2010 2010Date 12/31/2009 3/31/2010 6/30/2010 9/30/2010 12/31/2010

Sales 523.50$ 533.97$ 541.98$ 547.40$ 551.50$ 2,175$ Cost of Sales 359.07$ 362.53$ 367.09$ 369.87$ 371.75$ 1,471$ Selling, General & Admin 64.74$ 59.08 54.62 55.21 55.67 225$ Depreciation & Amortization 10.50 13.85 13.99 14.13 14.28 56$ Interest Expense 17.62$ 19.16$ 19.64$ 20.23$ 20.83$ 80$ Pretax Income 71.58$ 79.36$ 86.65$ 87.96$ 88.98$ 343$ Income Taxes 19.69$ 25.39$ 27.73$ 28.15$ 28.47$ 110$ Net Income 51.88$ 53.96$ 58.92$ 59.81$ 60.51$ 233.20$ EPS 0.48$ 0.50$ 0.55$ 0.55$ 0.56$ 2.16$

TargetP/E 17 36.76$

P to FCF 13 36.17$ P to Sales 1.7 34.28$ P to Book 1.9 41.46$

37.17$

Multiple

Weighted Avg

Page 4: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 4

Price and Growth Comparables

PE Multiple Revenue & Earnings 10yr CAGR

Thurs 3/4/2010

At 21x earnings, AME is more expensivethan the 16.5x normalized industry average…

Source: S&P Compustat. Sales Growth is 10 year CAGR, 1999-2009. Industry is GICS Electrical Components & Equipment Sub-Industry firms with market capitalizations above $1 billion.

Firm Trailing PE Norm PE

Ametek 21.0 20.7

Regal-Beliot Corp 21.6 14.7

Rockwell Automation 44.1 19.0

Roper Industries 21.6 15.7

Thomas & Betts 18.5 13.0

Woodward Governor 22.5 22.9

Industry 21.2 16.5Source: S&P Compustat. Industry is GICS Electrical Components & Equipment Sub-Industry firms with market capitalizations above $1 billion. Normalized P/E’s are 5 year normalized (2005-2009).

Firm Revenue EPS

Ametek 7.9% 13.0%

Regal-Beliot Corp 12.0% -8.9%

Rockwell Automation -2.8% 17.6%

Roper Industries 12.2% -252%

Thomas & Betts 9.9% -3.1%

Woodward Governor 11.6% 11.8%

Industry 8.2% 5.9%

… because of AME’s historically high earnings growth rate.

Page 5: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 5

AME’s Growth Drivers

Growth Drivers

1. Robust economic growth

2. Gross margin improvement from differentiation.

3. Net margin improvement from M&A synergy realization.

What Justifies 21x P/E?

Thurs 3/4/2010

13% ten year CAGR of earnings What is the future of these drivers?

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

$0

$50,000,000

$100,000,000

$150,000,000

$200,000,000

$250,000,000

$300,000,000

$41,739,000$60,768,000$68,532,000$66,111,000

$83,698,000$87,815,000$112,711,000

$140,643,000

$181,934,000

$228,020,000$246,952,000

Page 6: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

Agenda

Thurs 3/4/2010

1. Highlights of a Hold2. Macroeconomic Forecast3. The Margin

Expansion Story4. Summary

Page 7: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

AME Levered to GDP Growth

AME Share Price to Real GDP AME Sales Growth to Real GDP Growth

Thurs 3/4/2010 CFA Philly IRC - Scranton Team 7

Sources: Yahoo Finance, Historical Prices;Economagic, Real GDP Chained Weighted In 2005 Dollars

Sources: S&P Compustat, AME Sales; Economagic, Real GDP Chained Weighted In 2005 Dollars

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Real GDP Growth (Left Scale) AME Sales Growth (Right Scale)

Real

GD

P G

row

th

AM

E Sa

les

Gro

wth

$10,000,000,000,010.0

$10,500,000,000,010.0

$11,000,000,000,010.0

$11,500,000,000,010.0

$12,000,000,000,010.0

$12,500,000,000,010.0

$13,000,000,000,010.0

$13,500,000,000,010.0

$14,000,000,000,010.0

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

Real GDP (Left Scale)AME Share Price, Annual Average (Right Scale)

Real

GDP

AME

Shar

e Pr

ice, A

nnua

l Ave

rage

Page 8: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

Where is GDP Now?

Contributing Real GDP Factor Q1 Q2 Q3 Q4

Real GDP -6.4 -0.7 2.2 5.9

Consumption 0.4 -0.6 1.9 1.2

Investment -9.0 -3.1 0.5 4.6

Inventories -2.4 -1.4 0.7 3.9

Net Exports 2.6 1.7 -0.8 0.3

Government -0.5 1.3 0.6 -0.2

Thurs 3/4/2010 CFA Philly IRC - Scranton Team 8

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

1.23%

4.63%

3.88%

Q409 % Change in Contribution to Headline Real GDP

Consumption Investment InventoriesReal GDP, Table 2Bureau of Economic AnalysisData published February 26, 2010 Seasonally Adjusted at Annual Rates Quarterly Data from 1947 to 2009

Page 9: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 9

Where Does GDP Leadership Come From?

A Stroll Down Memory LanePercentage Contributions

to Real GDP Growth

Thurs 3/4/2010

Recession Initial Rebound

Sustained Recovery

Current Investment What Will it Be?

2002 Investment Consumption

1991 Consumption Consumption

1983 Consumption & Investment Investment

1980 Investment Double Dip

1975 Consumption Consumption1975 1980 1983 1991 2002 2009

-4

-2

0

2

4

6

8

C I G NX Source: Bureau of Economic Analysis, 2/26/10Seasonally Adjusted at Annual Rates, Quarterly Data

The basis for a sustainable and robust recovery is uncertain.

Page 10: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

Consumer Expectations and Consumer Confidence

• Negative Wealth Effect• Poor employment

outlook• Income expectations• Tax expectations

Thurs 3/4/2010 CFA Philly IRC - Scranton Team 10

Page 11: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

Sustained Consumption: What's The Function?

• Strong Q3 2009 consumption data: Up 1.9% sequentially

• Consumption contributed over 86% of headline GDP change in Q3 2009.

• Q4 Consumption: the “clunker” hangover

GDP

C

Durables

MV & Parts

Non-durables Services

I G NX

1 2 3 4

-30

-20

-10

0

10

20

30

40

50Q/q % Change in Contribution to PCE

Personal consumption expendituresGoods Durable goods Motor vehicles and parts

Page 12: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

Cash Strapped Consumers

Personal Income - Taxes= Disposable Personal Income (DPI)

DPI – Savings - Debt Service = Expenditure Capabilities

Thurs 3/4/2010 CFA Philly IRC - Scranton Team 12

2000-2009 Average 2009 Average0

100

200

300

400

500

600

$260 B

$470 B

Personal Savings

Bureau of Economic AnalysisData published February 26, 2010

3470035796

3689237987

3908310

11

12

13

14

15

Household Debt Payments as a % of Disposable Income

Page 13: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

Agenda

Thurs 3/4/2010

1. Highlights of a Hold2. Macroeconomic Forecast3. The Margin

Expansion Story4. Summary

Page 14: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 14

The AME Margin Expansion Story

Two Types of ME

1. Gross profit margin expansion from the switch to differentiated products

2. Net profit margin expansion from M&A-related synergies

Margins Over Time

Thurs 3/4/2010

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009-200

-150

-100

-50

0

50

100

150

200

Gross Margin ExpansionNet Profit Margin Expansion

Mar

gin

Expa

nsio

n, b

ps

Page 15: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 15

Gross Margin: Switching to Differentiated Products

Thurs 3/4/2010

98 99 00 01 02 03 04 05 06 07 08 0970%

72%

74%

76%

78%

80%

82%

84%

86%

88%

1998: 70% differen-tiated

2009: 87% differen-tiated

Page 16: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 16

Net Margin: Acquisition Synergies

Conceptual Model

: Margin Improvement due to Acquisition Synergies

: Average Acquisition Target Margin Improvement

: Acquired Revenue, Period t: Total Revenue, Period t

: Average Target Revenue, Period t: Number of Acquisitions, Period t

Hypothetical Exercise:Double Size of AME in 5 Years

Thurs 3/4/2010

“Beware of geeks bearing formulas…”- Warren Buffett, Berkshire Hathaway

MI AS t=ATMI t∗ARtTR t

% of Revenue Eligible for Synergy-related MI

Average BPS of synergies wrung from acquisitions

2003-2009a Yearly Average 2015e

Total Revenue $1.76B $3.5B

Acquired Revenue $170MM $340MM

Acquisition Contribution 9.5% 9.5%

2003-2009a

2015e

Option 1:Double NA

Option 2:Double ATR

$45MM $45MM $90MM

3.7 per year 7.5 per year 3.7 per year

$170MM $340MM $340MM

ARt=ATRt×NAt

Management Distraction?

Can be maintained?

Page 17: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 17

Net Margin: Acquisition Synergies

Industry Study

Thurs 3/4/2010

0.25 - 0.5

0.5 - 1.0

1.0 - 2.0

2.0 - 3.0

Over 3.0

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

Annual Revenue ($B)

Ope

ratin

g Le

vera

ge R

atio

(SG

A/C

OS)

Source: S&P Compustat, 2005-9 Average operatingleverage in the GICS Electrical Components & Equipment Sub-Industry, 142 firms.

Operating Leverage

• In this industry, larger companies typically have less operating leverage

• There are less fixed costs (SG&A) in larger companies

• Since most acquisition synergies come from SG&A, this means a lower potential for .

Page 18: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

Agenda

Thurs 3/4/2010

1. Highlights of a Hold2. Macroeconomic Forecast3. The Margin

Expansion Story4. Summary

Page 19: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

CFA Philly IRC - Scranton Team 19

Summary

• Ametek has relied upon 3 factors to drive growth:1. Robust economic growth2. Gross margin improvement from differentiation.3. Net margin improvement from M&A synergy realization

• These factors cannot be relied upon going forward to deliver the same growth.

• AME has a solid and experienced management team

• Yet a 21x P/E multiple is still rich given the risks associated with finding new sources of growth

Thurs 3/4/2010

Page 20: CFA Institute Investment Research Challenge Scranton Team Presentation - Ametek

Disclosures

Thurs 3/4/2010

Ownership and material conflicts of interest:The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation:Compensation of the author(s) of this report is not based on investment banking revenue.Position as a officer or director:The author(s), or a member of their household, does not serves as an officer, director or advisory board member of the subject company.Market making:The author(s) does not act as a market maker in the subject company’s securities.Ratings guide:Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months.Investment Research Challenge and Global Investment Research Challenge Acknowledgement:The CFA Philadelphia Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment Research Challenge originally developed by the New York Society of Security Analysts.Disclaimer:The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Philadelphia, CFA Institute or the Global Investment Research Challenge with regard to this company’s stock. Contacts

Faculty ContactDr. Murli Rajan, [email protected]

Student ContactFred Fuchs ‘[email protected]

Special Thanks ToChris Ouimet, Industry MentorThe CFA Society of Philadelphia

Ametek