Waters Back On The Right Path, But The Valuation Is Well Down The Road

 

Waters (WAT) needed shaking up, and new CEO Udit Batra is doing exactly that. In addition to what Batra has cited as weak execution under prior management, I believe complacency and a lack of strategic vision (and/or a lack of understanding where the life sciences and biopharma markets were heading) put Waters on its back foot, leading to unimpressive performance relative to names like Agilent (A), Bruker (BRKR), Danaher (DHR), and Thermo Fisher (TMO) over the last five years.

I'm a fan of what Batra is doing with Waters, and I think the company is already emerging as a more formidable player. The only issue is that the market seems fully onto this story, if not ahead of the curve. While I do believe this new, better, strategic path can deliver better financial results, it's hard for me to see how that isn't already captured in the share price (and then some).

 

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Waters Back On The Right Path, But The Valuation Is Well Down The Road

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

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: 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

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: 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

Seeking Alpha: Tiny MOCON Worth A Little More Attention

I like under-followed companies, and it's hard to be much less followed than MOCON (MOCO). This small analytical/measurement tools company is passingly similar to larger scientific tools makers like Agilent (A), Thermo Fisher (TMO), and Waters (WAT), but MOCON is largely focused on gas/vapor permeation instruments and packaging testing for the food, beverage, pharmaceutical, and consumer goods sectors.

On first blush, MOCON may not seem to be worth the work. There are no sell-side analysts following the stock, and the low volume and float will have it stricken off the list of many would-be institutional holders. A trailing P/E of nearly 24 and EV/EBTIDA of more than 10 also don't look cheap at first glance, though I believe a free cash flow approach suggests a fair value north of $20. Provided the company can stay on track with its margin improvement efforts, I like the long-term outlook for this tiny instruments company.

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Tiny MOCON Worth A Little More Attention

The Motley Fool: Waters Corporation: Picks And Shovels Don't Always Sell Cheap

Life science tools companies like Waters Corporation (NYSE: WAT  ) , Thermo Fisher Scientific (NYSE: TMO  ) , Agilent (NYSE: A  ) , and Danaher (NYSE: DHR  ) are often described as "picks and shovels" plays on pharmaceuticals, biotech, and specialty chemicals, as these companies sell to a wide range of companies in those industries and have far less of the development risk or regulatory burden. True as that may be, these companies don't often trade cheaply and Waters is no exception.

Even though the Street has grown concerned about Waters' organic growth, these shares continue to trade at a double-digit EV/EBITDA multiple, a 50% premium to the company's expected growth over the next few years. Waters should see improving demand from the pharmaceutical space as clients work through R&D restructuring programs and Waters is well-positioned in emerging markets. There is also the possibility that a change in management (the company is searching for a new CEO) could bring with it a new approach to acquisitions. Even with that, though, it would seem that investors are not likely to see double-digit appreciation from today's price level.

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Waters Corporation: Picks And Shovels Don't Always Sell Cheap

Seeking Alpha: Gravity's Only A Theory With Neogen

Neogen (NEOG) is one of the more remarkable med-tech companies out there, but I'll bet it's all but unknown to a large swatch of the Seeking Alpha reading audience. This relatively small ($1.4 billion market cap) med-tech has grown its revenue by an average of 16% a year for the past 10 years, with the stock price rising almost 900% over that same stretch of time, and there could yet be ample room to the upside.

The problem is that Neogen always looks expensive and I just cannot get comfortable with the idea that the stock's multiples will always continue to defy gravity. While the company's record of organic growth, solid margins/ROIC, and accretive acquisitions would make this a very dangerous stock to short, I'd nevertheless need to see a substantial sell-off before wanting to buy it as anything more than a growth trade.

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Gravity's Only A Theory With Neogen

Investopedia: Agilent Isn't Making It Easy On Investors

It's getting harder for me not to view Agilent (NYSE:A) as something like the store-brand version of Danaher (NYSE:DHR). It's cheaper and pretty close to the real thing, but it's just not quite the same and sometimes those differences leave you walking away unsatisified. To be sure, I think Agilent could do a lot to close this gap, but I'm not sure they will. Consequently, while Agilent is a little bit undervalued, it's harder for me to be as enthusiastic about buying shares today – particularly when Danaher seems undervalued to a similar degree.

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Seeking Alpha: If Agilent Weakens Further, Take Advantage Of It

As a high-quality company with strong share in most of its addressed markets, Agilent (A) doesn't frequently get all that cheap. The initial reaction to a weaker-than-expected fiscal first quarter has been pretty restrained as of this writing, but investors may want to sharpen their pencils and get ready to move on this name. Agilent has cyclical volatility and exposure to weaker government spending, but represents a good quality growth name at the right price.

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If Agilent Weakens Further, Take Advantage Of It

Investopedia: FEI Still A Big Play On The Very Small

The big upswing in the market has swept up many high-quality names and taken a lot of value with it, including the shares of nanoscale microscopy specialist FEI (Nasdaq:FEIC). Fast-growing new markets and a recovery in the semiconductor industry offer significant long-term revenue generation opportunities, but order patterns can be lumpy. While not an obvious bargain today, these shares are nevertheless worth watching by investors looking for an analytical instruments company with broad industry exposure.

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Investopedia: Pricey Today, IDEX Deserves A Spot On Watchlists

The recent strong performance by the stock markets has reduced the number of appealingly priced stocks to choose from these days. That certainly fits IDEX (NYSE:IEX), as this mid-cap industrial conglomerate has ridden a one-third move in its stock price to a recent new 52-week high. Although not so expensive that it's a short or a must-sell, patient investors may want to relegate this name to a watch list. The company's deep customer relationships and diverse industrial exposures are attractive, but not necessarily at today's valuation.

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Investopedia: Agilent Still A Name Worth Owning

Even for companies with a solid record of performance, macro and sector worries can dominate the story to a large extent. That would seem to be the case with Agilent (NYSE:A), as worries about the recovery in electronic test and measurement and the health of the life sciences market weigh down the shares of what is otherwise a very interesting and well-run company. Although Agilent may not be the best pick for investors who want to make a fast buck, investors with a long-term inclination should take a deep dive into this story.

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Investopedia: Forget Nano, FEI Is Real

Like all fads, the craze for everything "nano" pushed up a lot of junk stocks and produced few real companies before investors moved on to the next new new thing. While FEI Company (Nasdaq:FEIC) has gotten attention for its nano credibility, investors would probably do well to see this more as an analytical technologies company like Waters (NYSE:WAT), Thermo Fisher (NYSE:TMO) or Agilent (NYSE:A) than a hot next-generation tech story.

While the company does still have a large footprint in the cyclical electronics sector, the company is finding more and more applications for its technologies in sectors like natural resources and life sciences. Moreover, as the company continues to drive down the costs of its own technology, electron microscopy adoption could grow at an accelerating rate, as it has happened before with many other analytical technologies.

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Investopedia: Neogen Is Almost Cheap

Investors who want to play the really interesting stories in med-tech have to be ready to act fast or step up when times look uncommonly tough. That's about the only way to get a decent valuation on stocks like Intuitive Surgical (Nasdaq:ISRG), Cepheid (Nasdaq:CPHD) or Illumina (Nasdaq:ILMN), and that seems largely true for animal and food safety specialist Neogen (Nasdaq:NEOG). Although valuation and earnings quality are still problematic here, these shares also highlight the importance of being up-to-date on research and able to pull the trigger quickly.

A Disappointing Second Quarter  
Although Neogen doesn't generally step far out of line, this quarter was a notable exception. Revenue rose just 2% this quarter, not only missing the averaged estimate but missing the low-end estimate as well. Animal safety revenue was up just 1%, due at least in part to lower activity in the GeneSeek agricultural genomics business. Food safety was hardly stellar, though, as revenue was up just over 3% this quarter.

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Investopedia: Renewed Realism May Make Life Tech A Buy

It's easy to get sucked into the "gee-whiz" aspect of a lot of new technology, and that probably explains why bubbles are much more common in tech and health care than in industrials or transports. It's easy to dream of how gene sequencing might change the world; quite a bit harder to imagine the same from a new hydraulic component. Unfortunately, the reality is that life sciences is not the eternal growth engine that investors have long hoped.

Although investors in life sciences stocks like Life Technologies (Nasdaq:LIFE) have seen a lot of pain as Wall Street reorients its expectations, the worst may be over. With more realistic expectations in place, it may be time to consider Life Tech as a good blue-chip play on a sector that may not be the stuff of dreams, but is hardly a nightmare. (For related reading, see A Primer On The Biotech Sector.)

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Seeking Alpha: Survey - Life Sciences Could Be In For A Rough Year

Investors hoping for a quick turnaround in battered life science companies like Illumina (Nasdaq: ILMN), Pacific Biosciences (Nasdaq: PACB), and Affymetrix (Nasdaq: AFFX) may want to consider new information that suggests the next twelve months could be just as bad, if not worse. A recent survey from GenomeWeb and Mizuho indicates that research labs are battening down the hatches in expectation of poor funding trends and may well be spending less money (and spending that money differently) in the near future.

The Money Tree Is Looking Bare
For all of the talk about how life science discoveries in fields like genomics and proteomics has, is, and will influence Big Pharma and biotechnology, the reality is that it is not companies like Pfizer (NYSE: PFE) and Novartis (NYSE: NVS) that really make up the bulk of this sector's customer base. Life sciences is really an academic lab market – and those labs depend upon the federal government for an exceptionally large percentage of their funding needs. With stimulus spending in the past and the likelihood of lower funding levels for organizations like the National Institutes of Health and sub-institutes like the National Cancer Institute becoming more and more real, the situation is starting to get a bit scary.

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Survey: Life Sciences Could Be In For A Rough Year

Investopedia: Illumina Investors Get Schooled

For some time I have been warning Illumina (Nasdaq:ILMN) investors that they ignored Congressional budget wrangling, and the health of state university funding, at their own peril. Apparently that all came home to roost this quarter, as Illumina announced a significant shortfall in its third quarter revenue and warned that the fourth quarter could be difficult, as well. Though Illumina is clearly a technology leader, and likely will remain so for at least the near term, its customers don't fully control their own spending and that has been an underappreciated risk factor in the stock.

Problems Come Home to Roost in Q3  
After the close on Thursday, leading life sciences tools company, Illumina, announced that revenue for the third quarter was going to be well short of prior expectations. Though management has typically been conservative with guidance, and often surpassed it, revenue for the third quarter looks like it will be on the order of $235 million, well short of the $278 million average estimate and also well short of the $260 million Street-low estimate.

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Investopedia: Agilent Beaten Down To Bargain

You would think that a company with a global revenue base, diverse industry exposure and solid returns on capital would get the benefit of the doubt. But in the case of Agilent (NYSE:A), you would seem to be wrong. Agilent may not command as much respect for technology leadership as a company like Illumina (Nasdaq:ILMN), but Agilent's diverse and growing business deserves more respect and investors should consider using this market pullback as a chance to buy some shares in this high-quality company.


Third Quarter Results Better than Feared
Even though there was not much sign of it in the published analyst estimates, sentiment had definitely been souring on Agilent going into this earnings cycle. Nevertheless, Agilent reported that sales grew more than 22% in the fiscal third quarter, with 19% organic revenue growth. Growth was led by the electronic measurement segment (up almost 24%), where growth in the communications business was especially strong. Life sciences delivered solid 21% growth (18% organic), and chemical analysis was the "laggard" with 16% reported and 11% organic revenue growth.


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