Scientific Investing with Thermo Fisher Scientific

Thermo Fisher Scientific (TMO) is the combination of Thermo Electron and Fisher Scientific, which was purchased on November 9, 2006. The company has two major business lines - Analytical Technologies and Laboratory Products and Services.

Year …... Sales ….. C/F ….. EPS …... B/V ….... Avg. P/E

2001 ….. 12.41 ….. 1.27 …. 0.69 ….. 10.82 …… 34.3x

2002 ….. 12.81 ….. 1.36 …. 0.88 ….. 12.49 …… 21.4x

2003 ….. 12.71 ….. 1.49 …. 1.10 ….. 14.44 …… 19.0x

2004 ….. 13.74 ….. 1.57 …. 1.24 ….. 16.60 …… 22.9x

2005 ….. 16.21 ….. 1.85 …. 1.54 ….. 17.19 …… 18.4x

2006 …... 9.10 …... 1.44 …. 1.79 ….. 33.37 …… 21.3x

2007 ….. 23.47 ….. 4.66 …. 2.65 ….. 34.89 …… 19.8x

2008 ….. 25.45 ….. 5.20 …. 3.14 ….. 35.60 …… 17.5x

Figures from 2006 reflect just 7 weeks as a combined entity, while 2007 and 2008 numbers reflect the Fisher Scientific purchase on a full-year basis.

Thermo's balance sheet is in good shape with long-term debt at just 12% of capitalization and total interest coverage is greater than 12x. Value Line assigns TMO a 'B++' financial strength rating. Value Line also notes Thermo's 95th percentile rankings for both 'earnings predictability' and 'stock price growth persistence'. These shares have outperformed 95% of the 1700 company Value Line stock universe over the past decade.

At Friday's quote of $31.45, TMO shares are offered at just 10x this year's expected EPS of $3.14 and under 9x next year's estimate of $3.50.

This is the lowest valuation for Thermo Fisher Scientific on record. Its 10-year median P/E has been 24x and Value Line is assuming an 18 multiple for its 3–5 year normalized projections.

TMO shares look to be a fine example of GARP (Growth at a Reasonable Price). This is a high-quality growth story at a decidedly non-premium price point right now.

Even 12 times next year's consensus view of $3.50 EPS would bring TMO shares back to $42 or + 33.5% from Friday's price. That's a very low ball target as these shares touched highs of $46.30, $62, and $62.80 in 2006, 2007 and 2008 respectively when fundamentals were nowhere near as good as they are today.

Disclosure: Author bought shares of TMO on Friday.

Comments

[Tom Armistead:]

Thanks, looks like a good idea

2008 Dec 07 01:14 PM

[Dan Jacome:]

I like your pieces b/c they are short and you focus on valuation, but it'd be awesome if you could add a quick paragraph of what the companies do to make money, and why their business is attractive (ie. investment thesis and/or key drivers - why should I pick stock A if stock B does the same thing, etc.) You don't have to take my advice at all; I just think you could round out your articles a bit better : ) - Thanks and keep up good work !

2008 Dec 08 12:25 AM

[Paul Price:]

From today's Barrons:

IN DISCUSSING Thermo Fisher Scientific (TMO), let's take up the misgivings about the stock first, as they are minor and easily outweighed by its virtues.

The first knock is the mere fact that the sell-side speaks with unanimous approval of the stock, with a dozen analysts following it and a dozen recommending its purchase at today's price of 33.80. This was also the case when, six months ago, the stock was above 60. Then, the stopped clock was wrong, but at the moment it seems right on.

For years the stock carried a persistently rich valuation, and universal respect as a core growth-portfolio holding. Now, despite the analysts' continued endorsement, investors have added the stock to the overflowing bin of businesses cast aside in the general fear of sinister recessionary forces.

And, for sure, Thermo Fisher isn't immune to a shrinking economy, despite the avid pleadings of analysts who were bullish with the stock above 60 last summer. It may struggle to show revenue growth this year. But the shares seem to reflect the likely growth challenges and more.

Thermo Fisher is the product of the 2006 merger of Thermo Electron, a scientific instrument maker, and Fisher Scientific, a laboratory-products highflier. The company sells to labs and research operations of all sorts -- medical, scientific, academic, industrial -- providing good diversification of end markets.

Several concerns have punished the stock, including fears that colleges and government agencies will be scrimping. Yet with 70% of revenue from consumables (chemicals, vials, etc.) and only 30% in bigger-ticket instruments and machines, the business mix is nicely defensive. About half the instrument sales are to hard-put petrochemical and other cyclical buyers. Yet, again, these worries appear well accounted for by the uncharacteristic cheapness of the stock.

The formal Street consensus for earnings in 2009 is $3.35 a share, up from an expected $3.12 in 2008. It is hard to argue the market "believes" the official forecasts, because this is too strong a business to trade at only 10 times the market's best guess of current-year profits.

Thermo Fisher, with a $14.2 billion market capitalization, has only $1.1 billion in net debt, with no maturities for years. Its reported earnings are essentially made up entirely of free cash flow, at a current run rate of $1.3 billion or so, making for a free-cash-flow yield of 9%. Management has shown steady profit-margin improvement in the years since the merger, and the company's returns on capital are superior.

Stock buybacks funded out of free cash flow have been large, if erratic. Investors in the current environment might like to see the company institute a common-stock dividend as well. The company has been an active and effective acquirer of smaller businesses, a game that might be on hiatus for now, yet ultimately it will again be a preferred consolidator of the industry.

Charles Kantor, a portfolio manager at Neuberger Berman and longtime Thermo Fisher owner, says that with the market already pricing in some downside risk to '09 earnings forecasts, "it is one of those times where when people simply believe whatever the new [earnings] number is, the stock should go up."

There is a chance the Street will get a feel for a new and believable profit target on Tuesday, when Thermo Fisher will present its case to investors at the JPMorgan Healthcare Conference. Even if not, this fearful market seems to have brought a one-time growth darling into the buy zone even of bargain-focused investors.

Jan 10 05:39 PM

[Paul Price:]

MONDAY, MAY 25, 2009
Barrons

By MICHAEL SANTOLI

An uncharacteristic business downdraft has hit lab-equipment giant Thermo Fisher Scientific -- and its shares. Why both could rebound.

THE MARCH OF SCIENCE HALTS FOR NO RECESSION. But in a particularly bruising downturn, the march slows.

This lesson has become clear to Thermo Fisher Scientific , the leader in laboratory equipment and supplies, a company that once expanded sales and profits in steady lock step, but since late last year has seen its business downshift uncharacteristically.

Many global companies last quarter would have welcomed the 15% drop in earnings per share that Thermo Fisher experienced, but minus signs are unfamiliar to the company and its investors.

Thermo Fisher's shares (ticker: TMO) sank from more than 60 last summer to the mid-30s, and earnings forecasts for 2009 have been tempered from once-aggressive to more-reasonable levels. As a result, the instrument maker, a former growth-stock favorite that had always sported a premium valuation multiple, is now available at an attractive price.

The company, produced by the 2006 merger of Thermo Electron and Fisher Scientific, sells a comprehensive array of laboratory equipment, instruments, supplies and services to the health-care, biotechnology, university and industrial sectors. Its products are a crucial, if uncelebrated, part of drug discovery, chemical development and environmental-quality projects.

The idea behind the merger was to unite the old Thermo's research-equipment offerings with the consumable lab goods sold through the old Fisher's ubiquitous trade catalogs. The result was an attractive balance between consumables and capital goods, and a revenue stream that came from several end markets, as the accompanying charts confirm.


Thermo Fisher's chief executive, Marijn Dekkers, who led Thermo Electron beginning in 2002 and engineered the merger, says the deal's rationale is playing out well. "We have made progress with our larger clients in persuading them to centralize and standardize their purchasing," he says, rather than allowing, say, each scientist in every lab at a hospital or university to decide on what kinds of products to buy.

Since the deal concluded, free cash flow has surged to $1.2 billion in 2008, a level the company expects to match or slightly exceed in 2009, despite an anticipated dip in earnings this year to a range of $2.80 to $3.10 per share from last year's $3.13.

This essentially means the company converts nearly all earnings to free cash flow -- a sign of a potent business model. Assuming free cash flow gets to the anticipated $2.80 a share, the stock would sport a free-cash-flow yield above 7.5%.

Though Thermo Fisher fell to 42nd from eighth place in the latest Barron's 500 ranking of large companies, based on return on capital, the company remained in the top 10% of Corporate America by this measure. Thermo Fischer has a $15 billion stock-market value. Its $500 million in net debt (debt minus cash) is less than half its annual cash flow.

Ironically, at a time when so many companies are being punished for their wounded, debt-stressed balance sheets, investors are pressing Thermo Fisher to spend its cash reserves or take on more debt to repurchase more of its stock. There remains $400 million in a current buyback plan, but Wall Street wants more -- a stance that could be short-sighted.

"Investors are preoccupied with what to do with our balance sheet," Dekkers says. "They are saying, 'Why not buy the heck out of the stock at these levels?' "

Instead, Dekkers insists, he would "like to keep our powder dry. We are in a fragmented industry and we would like to be able to do acquisitions."

Historically, Thermo Fisher has achieved mid-single-digit organic revenue growth, augmented by a few percentage points via acquisitions. It also has enjoyed 20%-plus earnings growth. The company has spent a total of $900 million for a dozen acquisitions since the 2006 merger that created it, while also repurchasing $1.1 billion of stock. Yet Dekkers hints of a stronger current appetite for deals.


With shares of lab-supply leader Thermo Fisher Scientific down more than 40% from their 52-week high, investors have a great opportunity to buy the stock on the cheap.

"We have a lot of platforms and a long list of opportunities in lots of areas -- [potential] deals [totaling] in the billions that are best done for cash," he says, in elaborating on his balance-sheet strategy.

There is a chance that the Street's wariness about possible big acquisitions will continue to dampen enthusiasm for Thermo Fisher shares, which are roughly flat on the year. Like many big, high-quality stocks, they have largely sat out the recent rally.

And, for sure, other headwinds persist for the company. In the first quarter, cash-hoarding hospitals and university labs all but stopped buying routine supplies, producing an almost unheard-of inventory flush. Analysts say this phenomenon has continued to a degree this quarter, though it can't go on for long.

Big pharmaceutical mergers threaten to shut down redundant research-and-development projects, a minor concern. And the industrial segment remains quite weak, with many idled chemical and other plants sapping demand for certain products.

Yet by now, such factors appear well-incorporated into Thermo Fisher shares and the Street's newly tempered earnings expectations for this year. The company, in issuing preliminary guidance for 2010 last week, is using conservative assumptions for the timing and pace of any economic lift, and it's managing its costs accordingly.


The stock consistently garnered a premium multiple to the broad market before late last year -- sometimes as much as 40%. Currently, the stock is at a 10% discount to the Standard & Poor's 500 trailing and forward multiples.

Further, BCA Research notes that health-care-equipment stocks have a strong record as a leadership group exiting bear markets, and it points out that lean inventories and the continued growth in health-care-facility expansion are favorable.

The Obama stimulus package contains an allocation of billions for several research-and-development programs, which could supply a positive jolt to demand. More broadly, too, the increasing need for sophisticated diagnostics, tests, targeted drugs and environmental aids means Thermo Fisher is in an enviable position as the leading supplier for such needs.

Analyst sentiment toward Thermo Fisher is, admittedly, lopsidedly bullish, with all 13 analysts covering the company rating the shares a Buy. This is sometimes a concern for investors, when contrarian reasoning prevails. Yet the stock appears under-owned by institutions, given that its three largest shareholders are big passive index-fund firms: Barclays Global Investors, Vanguard Group and State Street.

The Bottom Line

Thermo Fisher Scientific shares have been mostly flat during this rally. But the balance sheet is solid, and there is plenty of room for investors to rediscover the stock.This suggests there remains room for investors to discover, or rediscover, the stock, which seems not to hold much downside risk in view of Thermo's balance-sheet strength. If there's increasing confidence that the company can reassert its growth path, the shares would easily merit a price/earnings multiple of 14 or better, which could push the stock up into the mid-40s as 2010 rolls into sight.

Even though the market has rallied 40% since March, a 30% potential gain for a high-quality stock should hold some appeal.

May 23 07:34 AM