UL Solutions

UL Solutions reported second-quarter revenue of $816 million, an increase of 5% year on year, and nearly 7% organically. In turn, adjusted EBITDA margin totaled 26.8%, up 140 basis points year on year. Despite the expected results, the stock declined roughly 14% on the trading day.

Why it matters: Management bumped up 2026 capital expenditures guidance by an implied $30 million or so. Our rough math implies about 5% less free cash, but we don't think that was enough to move the stock. Instead, we ascribe the price action to investors taking gains off the table. Valuation is a tether on markets. While UL Solution operates from a position of strength in the testing, inspection, and certification market, particularly in industrial end markets, we think prior prices reflected both the quality of the business and the stock's upside. While some may fret about the higher capex required to fund aggressive facility expansions, we don't fret about the company's long-term ambitions, given its runway for growth as a consistent and defensive compounder. The result was strong, as evidenced by incremental margins in the mid-50s.

The bottom line: We lift our fair value estimate to $79 from $78 for narrow-moat UL Solutions. Nothing really changed our long-term view of the stock, as we had already baked in the higher capex guide. The time value of money more than offset these impacts. The stock now trades in 3-star territory.

Between the lines: The stock rarely sells to this extent. One could argue that the strength of the industrial segment alone warrants a higher moat rating, particularly given the incremental return opportunities. Assuming a wide moat, the stock would trade with 19% upside. The industrial and consumer segments drove results higher, with the former benefiting from strength in materials, energy, and automation, while the latter was helped by appliances and HVAC, among other markets. We expect strong operating leverage to continue to expand margins.

We lift our fair value estimate to $79 from $78 for UL Solutions. Nothing really changed our long-term view of the stock as we baked in the higher capital expenditures guidance. The time value of money more than offset these impacts. The main issue we take with bulls is the implied premium multiple applied to shares relative to other testing, inspection, and certification peers. Still, one could argue that the strength of the industrial segment alone means that UL Solutions merits a higher moat rating, particularly given the incremental return opportunities. Assuming a wide-moat rating, UL's fair value would rise to $93 from our current $79 fair value estimate.

We project a five-year organic revenue CAGR of nearly 6%, which is toward the top of the company’s 5%-6% target. We expect revenue growth to be driven by a combination of price increases and volume growth from new products. We expect the industrial segment to see above-average revenue growth, driven by megatrends such as the energy transition and the electrification of everything.

We expect adjusted EBITDA margins to improve on a consolidated basis, rising from approximately 26% in 2025 to just over 32% in 2030. We expect margin improvements across all segments. In particular, software and advisory, its lowest margin segment historically, has room for margin expansion as the company consolidates its offerings and achieves greater scale.

Consumer and industrial TIC are more mature business segments, but we still anticipate positive margin expansion due to operating leverage from higher revenue. UL’s industrial segment is expected to remain by far its highest-margin segment, with an adjusted EBITDA margin almost double that of its consumer segment.

We assign a narrow economic moat rating to UL Solutions based on intangible assets and switching costs within its industrial segment.

UL’s broad portfolio of technical accreditations and iconic brand within the safety science industry are the foundation of its competitive advantage. This is complemented by customer switching costs from ongoing certification services and the high cost of failure of products within its industrial segment.

UL Solutions’ intangible assets are derived from its brand equity and broad portfolio of service offerings built up since the firm’s inception in 1894. As of year-end 2023, UL Solutions offers over 650 technical accreditations and certifies against over 4,000 standards. These are supported by a technical team of nearly 10,000 scientists, engineers, and other specialized technical and regulatory experts. The firm has over 80,000 customers across 110 countries and 91 laboratories. This expansive technical portfolio of knowledge places UL’s breadth of portfolio in the same sphere as the handful of other global TIC firms.

UL’s brand is iconic within the safety science industry, appearing on billions of products globally. The UL Enterprise’s history dates to 1894 as part of the nonprofit Underwriters Electrical Bureau. Since then, the competitive landscape has expanded to include a limited number of other accredited laboratories, though UL has maintained its leading position in the industry. We believe UL’s brand is further supported by its ubiquitousness within the safety science industry.

UL Solutions is the for-profit branch out of three organizations under the broader UL Enterprise. The other two organizations (UL Research Institutes and UL Standards & Engagement) are nonprofits who conduct safety science research and standards development, respectively. This makes the UL Enterprise unique within the broader safety science industry, engaging in both the standards setting process (via nonprofit entities) as well as testing, inspection, and certification (via the for-profit UL Solutions).

Complementing UL Solutions’ intangible assets are customer switching costs, particularly for ongoing certification services. UL earns revenue across the TIC value chain, including: certification testing, ongoing certification services, and noncertification testing and other services. Initial premarket product testing is typically done in a UL laboratory and ensures a product meets the specific safety standard (certification testing). Once initial testing is complete, UL earns ongoing revenue via annual fees for listing and routine field inspections (ongoing certification services).

We believe the ongoing certification services portion of UL’s revenue carries high switching costs for customers. Changing providers may necessitate scrapping the existing system, while incurring significant time and effort to start from scratch with a new provider. Moreover, the cost of TIC services is typically a small percentage of the overall product cost. As such, customers are more likely to stick with the existing provider due to psychological inertia. Notably, the firm’s customer retention rate, based on its top 500 customers from 2019-22, was approximately 99% in 2023.

UL’s TIC services span industrial and consumer product end markets, and we believe its moat varies by segment. UL Solutions’ industrial segment comprises less than half of its revenue, but approximately three-fourths of its operating profit. We believe the robust profitability of this segment is attributable to intangible assets mentioned previously, but also to customer switching costs.

Industrial products operate in mission-critical industries dealing with components like electrical equipment and industrial automations which have a high cost of failure and high risks of personal injuries and deaths. These products are highly regulated, and TIC services are crucial to help ensure that customers’ industrial products meet mandatory standards for product safety, performance, and sustainability, among other criteria.

Hence, customers prefer to partner with providers such as UL Solutions, which has deep expertise in the field and a track record of delivering high-quality services. UL is also able to demand premium pricing. Moreover, industrial products tend to have longer product lifecycles than consumer products, supporting a longer tail of ongoing certification services revenue.

In contrast, we believe the dynamics in the consumer product TIC category differ, resulting in less favorable moat characteristics. Relative to industrial products, consumer products are less scrutinized for product testing, have a higher cost of failure, and have a shorter shelf life. As a result, we don’t believe UL Solutions’ consumer segment benefits from the same degree of customer switching costs as its industrial segment.

Complementing UL Solutions’ core TIC offering are its software and advisory services. We fail to award this segment a moat as inferior profitability relative to its core TIC services suggests a lack of material customer switching costs. While the company sees 70% of its global and strategic accounts engaging with both the TIC and S&A businesses, we look for improved profitability in this segment to warrant a moat. The limited overall size of these offerings (less than 5% of consolidated operating income) results in a limited impact on our consolidated moat rating for the firm.

The size of the global TIC market is growing amid more regulatory oversight and customers' focus on ESG compliance and transparency.

UL is positioned to benefit from megatrends, including the energy transition, ESG, and new mobility.

UL Solutions’ well-established brand equity, portfolio, and global scale give it durable competitive advantage, particularly in the US market.

Competitors are also expanding their portfolio and global scale as they pursue market share and may eat into UL Solutions’ customer base.

Material exposure to China poses risk should US-China trade tensions deteriorate meaningfully.

UL Solutions’ acquisition strategy could result in lower shareholder value accretion than anticipated.