Fears Of A Post-Pandemic Hangover Have Weighed On Thermo Fisher's Shares

 

When I last reviewed Thermo Fisher (NYSE:TMO) (“Thermo”) my view on the stock was that, while the price wasn’t out of line for other life sciences companies, the longer-term prospective return still wasn’t that great. Since then, sell-side analysts have dutifully kept hiking their price targets, but the shares have flattened out some on worries about the impact of a sharp falloff in COVID-19 testing in 2021.

COVID-19 testing is going to meaningfully decline (or at least I sincerely hope so), but Thermo Fisher has gained significant ground in areas like molecular diagnostics (PCR-based testing in particular) that I don’t believe it is likely to surrender. Moreover, bioproduction remains a very attractive market over the long term. On top of all of that, the company is likely to keep generating $7 billion or more a year in free cash flow, creating huge opportunities for capital deployment.

I have increased my long-term revenue assumptions on the basis of that larger long-term footprint, and I expect mid-single-digit long-term growth even from the elevated starting point of the COVID-19-boosted 2020 numbers. While I can’t call Thermo a “bargain” per se, I do see a more interesting potential return from these levels, and it’s hard not to like the long-term opportunities/markets Thermo serves.

 

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Fears Of A Post-Pandemic Hangover Have Weighed On Thermo Fisher's Shares

COVID-19 Highlighting Thermo Fisher's Broad Life Sciences Exposure

There aren’t all that many companies for which COVID-19 has been a positive development, but Thermo Fisher (NYSE:TMO) (“Thermo”) has seen demand for lab consumables and testing supplies surge during the pandemic. Thermo is likewise highly leveraged to present-day R&D efforts aimed at COVID-19 therapies and vaccines, as well as future production efforts. With the biopharma industry still ramping up its bioproduction capabilities, Thermo has plenty of growth to look forward to even once the COVID-19 tailwinds ease.

You don’t go into life sciences looking for bargains; there’s the occasional hidden gem here and there, but by and large, a cheap-looking stock is cheap for a reason. That doesn’t apply to Thermo; Thermo is a top player in the field and priced accordingly. While the long-term returns suggested by discounted cash flow aren’t all that robust, the valuation isn’t so out of line for sector norms, and few companies of this size have Thermo’s growth leverage, nor its demonstrated ability to build value from M&A.

 

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 COVID-19 Highlighting Thermo Fisher's Broad Life Sciences Exposure

Danaher Adds A Jewel To Its Crown

It's not too often that you see an M&A transaction that sends the shares of both companies meaningfully higher, but Danaher's (DHR) acquisition of most of General Electric's (GE) Life Sciences business is a good move for both companies. For GE, the deal brings badly-needed cash that will help shore up the business as CEO Larry Culp tries to turn that hamstrung behemoth around. For Danaher, this is a crown jewel acquisition that meaningfully enhances the company's life sciences business (particularly in bioproduction/bioprocessing) and gives it even more exposure to a fast-growing acylical business with strong margins.

Although pricey, the GE Biopharma deal boosts Danaher's long-term growth rate and margins, and I believe management's synergy/accretion expectations are credible if not conservative. It's hard to say that Danaher is cheap, but considering the enhanced exposure to a very attractive market, I understand why the shares trade where they do.

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Danaher Adds A Jewel To Its Crown

When It Comes To Danaher, 'More Of The Same' Is Usually Pretty Good

With Danaher’s (DHR) strong leverage to life sciences and diagnostics, and recurring revenue, the company is in a good place as the economy goes through its cyclical shifts. Moreover, the company has the luxury to invest for growth without really compromising its core quality, and the balance sheet leaves open the possibility for further growth-driving M&A. The “but” is that the company’s shares are typically richly valued and today is no exception. Although Danaher’s valuation isn’t so unreasonably by the elevated standards of life science tool companies, investors should at least realize they’re paying a premium for Danaher’s perceived quality and cyclical resilience.

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When It Comes To Danaher, 'More Of The Same' Is Usually Pretty Good

Danaher's Mix Likely To Be A Real Asset In 2019

It doesn’t seem like there’s as much disagreement now that industrial activity is slowing, and particularly in the so-called early-cycle sectors. Two years into this cycle, autos and electronics have weakened, and there are growing concerns about upstream oil/gas equipment, non-residential construction, trucks, and “general industrial” going into 2019. Challenging as that may be for companies like MMM (MMM) and Illinois Tool Works (ITW), it doesn’t really mean all that much for Danaher’s (DHR), and this multi-industrial’s strong leverage to less cyclical businesses like life science equipment, diagnostics, and water quality should add to the popularity of what is already a very well-regarded company.

Given Danaher’s end-market exposures, I think there’s a good chance that Danaher can continue to report healthy earnings growth trends in quarters where many of its industrial peers won’t. Although the valuation here is hardly cheap, that stronger relative growth could drive “flight to safety” investment decisions, though I do believe Danaher’s high valuation does create a risk of a sharper sell-off if its 2019 results disappoint and its end-markets don’t prove to be quite as safe as commonly thought.

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Danaher's Mix Likely To Be A Real Asset In 2019

PerkinElmer Lagging A Bit

It has been a so-so year thus far for PerkinElmer (PKI), and that has been true for many other life sciences companies as well. Thermo Fisher (TMO) and Danaher (DHR) have been stronger (with just under double-digit returns year to date), but Waters (WAT) and Mettler Toledo (MTD) have been weaker, and PerkinElmer has at least kept pace with the S&P 500.

While I like PerkinElmer's biopharma, diagnostics, and food safety businesses for the long term, the underlying performance for 2018 looks like it is on pace for "good, not great". With the shares trading a little below my typical hurdle rate but still offering a high single-digit estimated annualized return, I'd call this is a "high-interest hold" at this point.

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PerkinElmer Lagging A Bit

Danaher's Growing Leverage To Life Sciences Improves The Long-Term Outlook

As investors have become a little more concerned that the industrial recovery story has peaked, Danaher's (DHR) far larger skew towards health and life sciences has started looking better and better. At the risk of oversimplification, I think the greater skew toward health care/life sciences can partly explain why Danaher and Roper (ROP) have outperformed peers like 3M (MMM), Honeywell (HON), and Illinois Tool Works (ITW) over the last three months (although industrial-heavy Fortive (FTV) has led the group, so it's not a flawless hypothesis…).

Danaher doesn't look especially cheap, but that's been the norm for much of the company's history and it hasn't prevented the company from outperforming the S&P 500, as management continues to apply a proven successful model. With greater exposure toward long-term growth opportunities like diagnostics and bioproduction, I like Danaher's mix even if the valuation is not scintillating.

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Danaher's Growing Leverage To Life Sciences Improves The Long-Term Outlook

PerkinElmer Riding A Strong Cycle And Making Positive Long-Term Shifts

These are good times for PerkinElmer (PKI). The life sciences/pharma tool market is about as strong as it has ever been, and the company's pivot toward diagnostics and services should pay off in the years to come in the form of more revenue stability and better margins. If management can reverse a pretty uninspiring historical trend of underwhelming M&A integration and missing long-term revenue and margin targets, the future could be pretty bright for this company.

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PerkinElmer Riding A Strong Cycle And Making Positive Long-Term Shifts

Danaher Back On Track To Start 2018

It can get a little ugly when darlings lose their luster, and Danaher (DHR) took some dings in 2017, leading to underperformance relative to other multi-industrials like Fortive (FTV), Honeywell (HON), 3M (MMM), and Illinois Tool Works (ITW). Considering the last couple of quarters, though, it looks as though Danaher is back on better operational footing and that 2018 will be a more "Danaher-like" year.

Given that Danaher spun off most of its industrial exposure, I still see the risk that Danaher will underperform some of those aforementioned peers for a little longer, as industrial recoveries spur greater growth. Longer term, though, I'm not really concerned. Like Honeywell, I can't really say that Danaher is "cheap", but it does appear to be less expensive than most of its peers and something of a relative bargain.

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Danaher Back On Track To Start 2018

Halma's Model Continues To Drive Value For Shareholders

Strong revenue growth and healthy margins remain a heady mix for industrial investors, and Halma (OTCPK:HLMAF) (OTCPK:HLMLY) (HLMA.L) is a good case in point. The market has amply rewarded this diversified European safety, health, and environmental conglomerate for its ongoing growth, with the shares up 25% or so since the last time I wrote.

Halma's model of steadily acquiring leading businesses in defensible niches has a lot of room to run, but it's hard to reconcile what I regard as a very good long-term model with today's valuation. Trading at close to 20x next year's EBITDA, it's hard to argue that this is any sort of overlooked hidden gem at this point.

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Halma's Model Continues To Drive Value For Shareholders

IDEX Looks Like A High-Priced Recovery Play

Up almost 30% over the past year, IDEX (IEX) has not only outperformed comps like Dover (DOV), Xylem (XYL), and Colfax (CFX), but reached pretty heady valuation levels. While IDEX does have a quality collection of businesses that includes pumps, meters, and fluidics, not to mention a lot of specialty market exposure, the company's historical growth, margin, and free cash flow performance don't convince me that it's worth paying such a robust valuation today. Although I like the company's prospects for improving organic growth over the next few years and the opportunity for incremental M&A, not to mention the possibility of a lower tax rate, a mid-teens multiple on EBITDA and an implied total return in the mid-single digits on a DCF basis don't work for me.

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IDEX Looks Like A High-Priced Recovery Play

While Performing Well, The Expectations Around Agilent Are High

I was skeptical about Agilent's (NYSE:A) prospects for outperforming its peers back in the summer of 2015, but since then, Agilent shares have comfortably outperformed peers like Waters (NYSE:WAT), Thermo Fisher (NYSE:TMO), PerkinElmer (NYSE:PKI), Bruker (NASDAQ:BRKR), and Shimadzu with a 30% run that has also handily beaten the S&P 500. Management has done a better job than I'd expected of improving margins and streamlining/refocusing the business, and Agilent has also done better than I'd expected in the pharma space on the back of a strong liquid chromatography product cycle.

At the risk of sounding like a broken clock, the valuation on the shares still concerns me. The new (and improved) Agilent has been generating FCF margins in the mid-teens and while I think management can deliver upside on operating margins and asset efficiency, I'm not sure that meaningfully exceeding 20% FCF margins is highly likely. So while I do think Agilent is a good company in the life sciences tools space (and performing well), it's hard for me to get comfortable with a valuation that already assumes double-digit long-term annualized free cash flow and/or a forward EV/EBITDA multiple more than twice the likely growth rate over the next three to five years.

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While Performing Well, The Expectations Around Agilent Are High

Seeking Alpha: Pacific Biosciences Looking More Interesting Once Again

If you're a fan of The Simpsons, the performance of Pacific Biosciences (NASDAQ:PACB) (or "PacBio") may at times remind you of the Homer Simpson "bed goes up, bed goes down" scene. While the company continues to make steady progress in improving its systems and adoption and usage are both increasing, the market has batted the stock around in response to anticipated launch numbers, rumors of a buyout, and concerns over competing systems.

My core thesis on PacBio remains the same. This company has developed a sequencing technology that is very good at doing a limited (but important and significant) number of things within the overall sequencing opportunity. PacBio will never be another Illumina (NASDAQ:ILMN) or Thermo Fisher/Ion Torrent (NYSE:TMO), but it can grow to over $1 billion in revenue over time on the strength of opportunities in areas like microbial/viral genetics, plant/animal genetics, and human genetics and diagnostics (particularly oncology). With that, I still believe a low double-digit fair value is reasonable. Given the pullback in the shares since my last write-up, this looks like it may be a good time for some due diligence on the name.

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Pacific Biosciences Looking More Interesting Once Again

Seeking Alpha: Newly Agile Agilent May Yet Be Weighed Down By Expectations

The life science tools market doesn't offer quite as much organic growth as many investors seem to think, but the high barriers to entry, relatively short product cycles, and consumables/service streams do tend to support good margins for the established players. The question facing Agilent (NYSE:A) isn't so much about whether the company can remain a strong player in markets like separation, mass spec, and pathology, but rather whether the company can reverse a long history of failing to live up to expectations and truly make the most of its technology and market positions.

At this point I'm a skeptic. Agilent shares may hold some appeal if you believe they can generate Waters-level (NYSE:WAT) FCF margins relatively soon, but I consider that to be a very ambitious expectation. Likewise, I'm a little concerned about the company's relatively weaker position in clinical markets next to Waters, Thermo Fisher (NYSE:TMO), Danaher (NYSE:DHR), and Bruker (NASDAQ:BRKR). Although I have little doubt that Agilent as a company will be fine, I'm concerned that there's too much optimism in the shares now that Agilent operates as a pure-play on life science and science tools.

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Newly Agile Agilent May Yet Be Weighed Down By Expectations

Seeking Alpha: Pacific Biosciences Still Trying To Claw Out Its Own Niche

When it comes to sequencing, it's still pretty much Illumina (NASDAQ:ILMN) and then everybody else. Illumina has earned this place of prominence through consistent R&D productivity and opportunistic M&A, and it makes life difficult for would-be challengers to the throne like Pacific Biosciences (NASDAQ:PACB). That said, PacBio has continued to make solid progress, with the shares up more than 100% from when I first wrote on them as a Top Idea and up about 20% from my last update.

The challenge for PacBio remains what it has been for some time - build upon what is currently the best available technology for long DNA sequences and make it faster, cheaper, and easier to use. Wrapped within that, the company needs to continue to develop new systems and new technologies, as well as develop opportunities in areas like plant genomics, clinical diagnostics, and epigenetics where its technology can really stand out.

As a stock, PacBio remains highly speculative. It's partner Roche (OTCQX:RHHBY) has continued to pursue its own alternatives in sequencing (while remaining at least outwardly committed to its PacBio partnership) and major rivals like Illumina, Thermo Fisher (NYSE:TMO), Oxford Nanopore, and 10X Genomics continue to work on technologies and systems that could ultimately capture some or all of PacBio's targeted markets. Still, 10% of the sequencing market and success with its Roche partnership could still support close to $1 billion in revenue well down the road and an $8 fair value today.

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Pacific Biosciences Still Trying To Claw Out Its Own Niche

Seeking Alpha: Volatile Pacific Biosciences Continues To Make Progress

Early-stage next-gen sequencing company Pacific Biosciences (NASDAQ:PACB) continues to make progress both with its system specs and its end-market development, but the path is not smooth or easy. The shares are still up about 80% from my initial Top Idea write-up, but down about a quarter from my last piece as investors fret over the progress and competitive risks of Illumina (NASDAQ:ILMN), Thermo Fisher (NYSE:TMO), and Oxford Nanopore, as well as questions as to whether the company's development partnership with Roche (OTCQX:RHHBY) will deliver the hoped-for revenue and profits.

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Volatile Pacific Biosciences Continues To Make Progress

The Motley Fool: Illumina Inc's Seemingly Endless Victory Lap

It gets harder and harder to criticize a company's valuation when that company continues to surpass expectations and build its lead on its rivals. That is the basic story for Illumina (NASDAQ: ILMN  ) , as this company continues to distance itself from Thermo Fisher (NYSE: TMO  ) and other would-be sequencing competitors and build up its bona fides in the diagnostics market. With a diagnostics opportunity at least twice as large as the $2 billion sequencing market (and growing at a double-digit rate), there seems to be enough growth potential to keep investors keenly interested in this name.

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Illumina Inc's Seemingly Endless Victory Lap

The Motley Fool: What You Need to Know About the Agilent Technologies Split

There is no shortage of data, analysis, and opinion out there about the virtues (or lack thereof) of spinoffs and corporate splits. They don't always work, but I do believe that Agilent (NYSE: A  ) will be one of those companies that benefits, as there really never were meaningful synergies or counter-cyclical offsets between the test and measurement operations and the life science tools and diagnostics operations. Agilent still looks a little undervalued today and even with the added cost burden of the split, the life science and diagnostic operations in particular look well worth following.

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What You Need to Know About the Agilent Technologies Split

Seeking Alpha: Pacific Biosciences Looking To Carve Out Its Niche

High-end sequencing company Pacific Biosciences (PACB) still has much left to prove. The company has done a good job of improving system performance and reliability, but the 800lb gorilla in the sequencing space, Illumina (ILMN), books more orders for both its HiSeq and MiSeq platforms in a quarter than PacBio has installed in the field. PacBio's alliance with Roche (OTCQX:RHHBY) provided a significant boost to the stock, but it has yet to be established that the company can develop systems and tests that will work in the clinical diagnostics setting.

I continue to believe that PacBio has a worthwhile future, as I believe the company can address a multibillion-dollar opportunity by targeting applications where Illumina's technology does not work as well. Microbial and plant genetics, so-called "platinum genomes", and epigenetics are all areas where PacBio's technology can play a long-term role. This is by no means a stock for the nervous or impatient investor, but I believe opportunity remains even after the large move in 2013.

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Pacific Biosciences Looking To Carve Out Its Niche

Seeking Alpha: A Focus On Margins And Clinical Opportunities Could Transform Bruker

Due in no small part to the willingness of large life sciences companies to grow by acquisition, there are not all that many small-to-mid cap companies with solid technologies, products, or market shares. Bruker (BRKR) is definitely one of the outliers, as the company has established a significant presence in areas like nuclear magnetic resonance, molecular spectroscopy, and advanced X-ray technologies.

Bruker has historically been more focused on product development and revenue growth than profitability, but that has started to change. The company has also started to alter its end-market focus, with clinical microbiology emerging as a very worthwhile opportunity. Bruker certainly has to prove that it can execute, and competing with companies like Agilent (A), Danaher (DHR), and Thermo Fisher (TMO) is no picnic, but Bruker seems to offer some appealing growth potential. The valuation isn't a slam-dunk at today's price, but there are definitely some bull-case drivers that could emerge to propel even better sales and margin performance down the line.

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A Focus On Margins And Clinical Opportunities Could Transform Bruker