Agilent: A Wide Moat Company Expected To Return To Growth In 2024 (Rating Upgrade)

It is higher to purchase an exquisite firm at a good value, than a good firm at an exquisite value – Warren Buffett

We imagine Agilent (NYSE:A) is among the uncommon corporations that may be known as a “great enterprise”. It’s doubtless that, because of this, it has traditionally tended to be fairly overpriced, and solely not often do traders get an opportunity to buy shares at near truthful worth.

The corporate has a really robust aggressive moat, first rate development, and glorious profitability. Usually, it operates in a horny business, the place mental property and excessive switching prices give corporations robust pricing energy. One of many causes for this buyer “stickiness” derives from the truth that regulation of the drug manufacturing course of disincentivizes clients from altering to a special software supplier, as they may must repeat validation processes. The opposite motive is that when clients familiarize themselves with learn how to function a given piece of kit, they do not wish to spend the time studying learn how to function a special one.

Firms like Agilent additionally profit from vital development within the biopharmaceutical sector by promoting an rising variety of instruments, consumables, and companies. Lengthy-term, the corporate believes it may develop revenues at a 5% to 7% charge, which together with some margin enchancment and share rely discount may end in double-digit EPS development.

We imagine the overall high quality of the enterprise has been bettering because the divestiture of Keysight Applied sciences (KEYS) in 2014. This digital measurements enterprise was highly-cyclical, and allowed Agilent to give attention to extra superior gear like chromatography and mass spectrometry instruments. One other enchancment within the enterprise was the implementation of the CrossLab technique, which goals to increase companies and consumables. This has resulted within the majority of Agilent’s income being recurrent, offering a lot better monetary visibility and decreasing buyer churn danger.

Firm Overview

Agilent instruments have functions in a wide range of finish markets corresponding to pharma & biotech, scientific and diagnostics, chemical, vitality, meals, and environmental functions. On the identical time, the corporate has a pleasant geographical diversification.

The corporate estimates most of its finish markets will develop between 2% and seven% long-term, with alternatives to extend market share in addition to elevated income from add-on companies corresponding to gear upkeep.

Development

We imagine the corporate’s income development goal to be credible, provided that because the Keysight Applied sciences divestiture, the corporate has averaged a quarterly y/y development charge of ~6%. Near the center of its 5% to 7% goal, even when current quarters have skilled detrimental development.

We imagine that is largely the results of a interval of over enlargement by lots of its clients in the course of the submit pandemic interval, and it’ll take a while to undergo the surplus.

It does appear a turning level could be close to, with CEO Mike McMullen not too long ago commenting on the Evercore ISI HealthCONx convention that noticed indicators of stabilization within the fourth quarter.

[…] within the fourth quarter, we really noticed what we noticed encouraging indicators of potential stabilization as a result of we had extra instrument orders than we had shipments. So we constructed backlog and we had a book-to-bill over one for the primary time. What, Bob in a number of quarters, I believe.

Different causes for optimism embody Agilent’s plan to additional increase its Nucleic Acid Options Division (NASD), which it believes is on the street to delivering greater than $1 billion in income.

The corporate can also be optimistic on the expansion of semiconductors and lithium-ion batteries. Agilent’s portfolio addresses your entire battery worth chain, from mining and supplies processing to cell elements and recycling. The corporate can also be to profit from quite a few new therapeutics available on the market which have a big affected person inhabitants measurement. It believes a few of this development will begin to be seen in 2024.

Financials

Agilent reported a small decline in income of -0.2% to $6.83 billion, principally the results of detrimental overseas change impacts. Nonetheless, thanks partially to a 30 bps enchancment within the working margin, the corporate was in a position to ship 4% y/y development in EPS. The fourth quarter noticed a major year-over-year income decline of -8.7% and an EPS of $1.38, down 10% in comparison with the earlier yr. A giant motive for the income decline was decrease demand for instrumentation, significantly in China and the pharma finish market. One shiny spot was CrossLab, which delivered one other stable quarter, rising +4%.

The corporate has been working onerous, decreasing its price construction to have the ability to develop earnings quicker than income. It has assured traders that among the issues it’s doing proper now are everlasting adjustments the place the price will not come again. One instance is rationalization of its actual property footprint. A few of these price reductions will have an effect in 2024 and aren’t anticipated to return again in future years. Wanting on the working margin over the previous decade, it’s clear that it has been trending larger.

Recurring Income

Some of the engaging traits of Agilent is the big share of recurring income it produces. This a part of the enterprise has been rising quicker than the remainder of the corporate, which makes it more and more essential when valuing the enterprise. As recurring income will increase, we imagine the next valuation a number of might be justified.

That is one thing that clearly excites CEO Mike McMullen, who mentioned in the course of the Evercore ISI convention that he’s very bullish on this a part of the enterprise.

So the entire assemble of ACG, Agilent and CrossLab was we handle your entire lab. We have been doing very, very effectively on the enterprise service as effectively. So we have been profitable a variety of multi-year massive engagements the place we’ll handle your entire fleet of the lab.

We’re additionally going to supply a variety of different companies along with that asset administration and different companies that our clients more and more want to corporations like Agilent to supply. So I am very bullish, I agree with I am undecided who you spoke to, however I am very bullish together with this particular person that there is a variety of alternatives for service and for us, it is turn out to be fairly a significant enterprise for us.

Steadiness Sheet

Whereas the corporate does carry some long-term debt, it may pay greater than half utilizing money and quick time period investments. With a web debt to EBITDA ratio of lower than 1x, we’re very comfy with the energy of the stability sheet.

Shareholder Returns

Agilent pays a small share of its earnings as dividends, which leads to a really modest dividend yield. Nevertheless, the corporate returns vital quantities to shareholders via inventory buybacks, which is mirrored in a shareholder yield of shut to three%.

Outlook

Agilent is guiding for income development to deteriorate much more within the first quarter of FY24, anticipating yr over yr core income development to be between -11.3% and -8.5%. Regardless of the powerful begin to the fiscal yr, the corporate expects FY24 to ship core income development within the vary of between -0.5% and 1.0%. Seen in a different way, the corporate expects to return to optimistic development within the subsequent three quarters. This seems to have been confirmed by CEO Mike McMullen on the Evercore ISI HealthCONx convention that they’ve “a view that we will get again to development in 2024”.

Valuation

Agilent is buying and selling very near its ten-year common EV/EBITDA a number of, nevertheless, we imagine the corporate to be a lot larger high quality right now than it has ten yr in the past. It has improved revenue margins, and the share of income that’s recurring.

It additionally seems to be moderately valued when in comparison with a few of its friends like Thermo Fisher Scientific (TMO), Danaher (DHR), and Waters Corp (WAT). In that group, solely Thermo Fisher Scientific has a barely decrease ahead P/E ratio, however the distinction is minimal.

Equally, when value to money circulate from operations per share, solely Danaher seems barely cheaper, and by a modest margin. We imagine general the entire group seems to be moderately valued.

Analysts on common count on FY24 to look similar to FY23 when it comes to gross sales and EPS, with a noticeable restoration till 2025. We imagine they’re being too conservative, and based mostly on feedback and steerage from administration, there are causes to be cautiously optimistic concerning the second half of FY24. Nevertheless, a possible derailment to the return to development may happen if a recession materializes subsequent yr within the US.

Based mostly on our future earnings estimates, we calculate a web current worth of $124 per share, which is near the present value. We subsequently imagine shares are priced to ship an affordable return, and are upgrading our ranking to ‘Purchase’ because of this.

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Dangers

The most important danger we see is that there is no such thing as a vital margin of security between our estimate for the intrinsic worth of the shares, and the place they’re buying and selling proper now. Apart from that, we imagine Agilent to be a a lot decrease danger in comparison with the typical inventory within the S&P 500 index (SPY) or the Russell 2000 (IWM). That is mirrored in its very excessive Altman Z score, which is comfortably above the three.0 threshold.

Conclusion

Agilent has skilled some headwinds in current quarters, and is predicted to see vital detrimental development subsequent quarter as effectively. Nonetheless, we imagine headwinds will finally dissipate, and the corporate will return to development. Agilent has a number of engaging qualities that make the corporate engaging to traders, together with a robust aggressive moat, buyer and geographic diversification, and a major share of its income being recurrent. We imagine the momentary headwinds have created a chance for traders to buy shares at an affordable valuation. Shares are buying and selling near our estimated truthful worth, and we imagine they provide a horny danger/reward to traders.