- Thermo Fisher has seen impressive results, as headline results this year are held back by pandemic-related revenues on their retreat and a strong dollar.
- Multiples have fallen to 20 times earnings, as higher interest rates have been a key driver behind this.
- The appeal is luring, yet in this market, I would like to see a little further pullback before initiating a position here.
Shares of Thermo Fisher Scientific (NYSE:TMO) have been pressured as well, as part of a group of high valued companies which are hurt by the impact of higher interest rates.
After shares peaked at $670 early this year, shares are down to the $500 mark, as the pullback is quite modest in relation to many other stocks, with shares still trading well ahead of pre-pandemic levels.
Back To 2019
In the summer of 2019 I last had a look at shares of Thermo Fisher, calling it a steady performer whose performance came at a cost, that of a high valuation. At the time, Thermo Fisher was a $25 billion scientific powerhouse, organized across four products. The largest segment was the laboratory products and service products, responsible for roughly 40% of sales. This was complemented by science solutions and an analytical instruments group, each responsible for roughly 20% of sales, as the company had a smaller specialty diagnostics segment as well.
The company derived half of its sales from North America and a similar percentage from consumables, yet the company was (and still is) quite diversified in terms of geographic activities and the division between equipment sales and consumables. On a revenue base of about $25 billion at the time, the company earned around $11 per share (on an adjusted basis), as the adjustment made look quite fair.
Net debt of $17 billion translated into a 2.8 times leverage ratio and with 405 million shares trading at $300 at the time, a $121 billion equity valuation and $138 billion enterprise valuation, worked down to a 5.5 times sales multiple and roughly 27 times earnings multiple. With growth evident throughout 2019, there was a real roadmap for earnings to grow to $12 per share, still translating into a premium 25 times earnings multiple, a bit too steep for me at the time.
Fast forwarding more than three years since summer of 2019, when shares traded around the $300 mark we did see shares rise to the $500 mark by the end of 2020, the first year of the pandemic. After a run higher to a high of $670, in part driven by low interest rates, shares are now down to $500 per share.
This year started with the completion of a $1.85 billion deal for PeproTech, a transaction announced late in 2021. A few weeks later the company announced its 2021 results, a hugely successful year in which sales rose 22% to $39.2 billion on which a significant $12.5 billion EBITDA number was reported.
Part of this rapid growth came as the company announced a huge $21 billion deal for PPD. While sales had risen more than 50% since the situation in 2019, earnings per share had essentially doubled with adjusted earnings reported at $25 per share. Deal making came at a cost, that of net debt increasing to $30 billion, yet with EBITDA inching up to $12.5 billion, this leverage ratio is still very manageable.
Through 2022 the company posted strong results with double digit growth posted in each of the first three quarters of the year. This means that revenues rose 17% to $33.5 billion in the first nine months of the year, at a run rate of around $45 billion. That is the good news as adjusted earnings per share so far are lagging some seventy cents compared to the earnings performance so far last year, reported at $17.84 per share.
Part of this lower earnings momentum came from the retreat in Covid-19 testing revenues as growth was driven by the PPD deal of last summer of course. Strong cash flow generation made that net debt fell to $26 billion and change, mostly as no large deals were seen this year and dividends are quite modest.
With nearly 400 million shares trading at $500 per share, Thermo Fisher commands a roughly $200 billion equity valuation here, a number increasing to $226 billion if we factor in net debt. This still works down to roughly 5 times sales and with earnings trending at $24 per share, valuations are reasonable at 20-21 times earnings.
A Bolt-On Deal
On the final day of October, Thermo Fisher announced a bolt-on deal again. The company has reached a deal to acquire specialty diagnostics firm The Binding Site Group, a UK-based firm in a $2.6 billion deal, equivalent to about a percent of the valuation of the firm.
The company is set to add $220 million in revenues, growing at around 10% per annum, revealing that a rather expensive 12 times sales multiple has been paid. With adjusted earnings set to increase by seven cents per share upon closing, that reveals an after-tax earnings contribution of $35 million. It is not sure if the company calculates this accretion ahead of financing costs, or thereafter.
Right now, the overall valuation has come down a lot already. A 20 times earnings multiple translates into an earnings yield of 5%, at par to, or just above, risk free rates, albeit that Thermo Fisher offers stability and appeal with earnings growth. Right now the business has a kind of transition year amidst pandemic related revenues on the retreat, but the long term prospects continue to look good.
The latest bolt-on deal looks a bit expensive, yet Thermo Fisher has a great deal making track record. Given all of this, I am getting upbeat here, albeit that many names are selling off in this environment. Given all of this, shares are slowly appearing on my radar as any pullback to the mid $400s will be used to start initiating a position here on the dips.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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