Thermo Fisher: A Growing Company With An Acquisition Strategy

Summary

• Thermo Fisher is a profitable company with moderate debt levels.
• The company’s earnings have shown strong growth over the last five years with more growth expected for 2020.
• Management is proactive and will divest any business unit that underperforms and replace it with new acquisitions that have the potential to perform.
• Thermo Fisher sees further growth opportunities in China.

Introduction

Thermo Fisher Scientific Inc. (NYSE:TMO) is a global company in the medical research industry providing instruments, equipment and software. The company’s has shown solid growth over the years and more growth is forecast for 2020.

Management is proactive and seeks out opportunities. The company’s acquisition strategy is to look for businesses that will provide future growth and management will even divest its own business units if they underperform. Also, the company is expanding its operations in emerging markets as a means of boosting growth.

Over the long term I think that Thermo Fisher has the potential to grow well into the future along with its stock price.

Financials

Thermo Fisher has reported financial results for the fourth quarter of 2018 (data from Seeking Alpha and Gurofocus).

The company’s reported forth quarter revenue was up 7.6 percent and reported diluted earnings per share up 70 percent from the fourth quarter of 2017.

On an annual basis, revenue for 2018 was up 16 percent and diluted earnings per share up 29 percent from the 2017 fiscal year. Over the last five years Thermo Fisher’s revenue grew 9.6 percent per year and its earnings increased 11.3 percent per year.

Thermo Fisher’s return on equity is fair at 11 percent. Over the last five years its return on equity has mostly been just under 10 percent. The profit margin (profit to revenue ratio) is good at 12 percent. The profit margin has been fairly consistent over the last five years.

Thermo Fisher’s current ratio is 1.7 meaning that its current assets exceed its current liabilities. The current ratio has average 1.5 aver the last five years.

The asset ratio (total liabilities to total assets) is 51 percent which means that Thermo Fisher’s total debt is 51 percent of the value of everything the company owns (note that the asset value is the book value and not the liquidated value of its assets). Over the last five years the asset ratio has been consistent at around 50 percent.

The company’s book value is currently $68.62 and with a stock price of $254 Thermo Fisher is trading at 3.7x book value.

The analysts’ consensus forecast is for revenue to increase by 3.4 percent in 2019 and increase 5.6 percent in 2020. Earnings are forecast to increase by 36 percent in 2019 and increase by 16 percent in 2020. The 2020 PE ratio is 22x.

The financials reveal Thermo Fisher is a profitable company that operates with a moderate amount of debt.

Earnings Risks

Thermo Fisher invested $0.9 billion in research and development. This represents a third of its 2018 net income of $2.94 billion. This is quite a significant sum, but Thermo Fisher must invest this to remain ahead of its competition.

Thermo Fisher has plenty of competition. Two large competitors are Becton, Dickinson and Company with revenues of $16 billion and Danaher Corporation with $20 billion in revenues. While Thermo Fisher is ahead of its compitition with $24 billion in revenue, it could easily loose its position if the other two up their their R&D spending to produce better and/or cheaper products. If this happens then Thermo Fisher would have to respond with increasing its R&D budget (which will reduce its net income) or it will have to reduce prices (if competitors new products are the same but cheaper). The end result is the same - reduced net income for Thermo Fisher.

Acquisitions

The company has a strong history of growth which can be largely attributed to its acquisition strategy.

Its latest proposed acquisition of Roper Technologies Gatan unit for $925 million has hit a snag with the U.K.’s Competition and Markets Authority (NYSE:CMA) having raised concerns that competition would be reduced for customers using their specialized microscopes. The concerns raised by CMA were that it would lead to higher prices or lower quality products. The acquisition if approved by CMA would generate $150 million in revenue (which represents 16 percent of its purchase cost).

Over the last four years Thermo Fisher has successfully acquired 9 businesses and divested one of its own businesses.

Thermo Fisher will divest its anatomical pathology business for $1.1 billion to Japan’s PHC Holdings Corporation. The deal is expected to close in the second quarter of 2019. This business unit is one of Thermo Fisher’s more mature businesses with a shrinking client base and is under pricing pressure from its competitors.

Thermo Fisher has a market-cap of around $100 billion and generates around $24 billion in revenue. This means its revenue represents 24 percent of its market-cap value. The anatomical pathology business unit generated only $85 million in revenue for the $1.1 billion it sold for. This represents only 8 percent of its value. I can see why management wanted to divest this business unit – its revenue potential is only one-third that of the company overall.

I think that getting rid of an underperforming business unit is a good move as the last thing Thermo Fisher needs is a business unit to drag down its growth. This also provides cash form the sale of anatomical pathology that Thermo Fisher can use to buy another business with better revenue prospects.

I like this proactive nature – sell underperforming business units and replacing them with business units that have growth potential.

Thermo Fisher has completed 9 acquisitions since 2015 with the most recent acquisition of Advanced Bioprocessing for $477 million in cash. The acquisition was completed in October last year and is expected to add $100 million in revenue (which represents 21 percent of its purchase cost). Now this is more to management’s likings – 21 percent is in the ball park for Thermo Fisher's 24 percent revenue to value ratio.

Thermo Fisher’s largest acquisition since 2015 was Patheon N.V. (a NYSE listed company) which was acquired for $7.2 billion in cash. The acquisition was completed in August 2017 and adds $1.9 billion in revenue (which represents 26 percent of its purchase cost). Again this is in the ball park for Thermo Fisher’s revenue of 24 percent of its market value.

Foreign Markets

While Thermo Fisher produces growth through its acquisitions strategy, it also generates growth from expanding into foreign markets.

As stated by Marc Casper - President and CEO in their earnings call,

In 2018 not only do we delivered excellent growth again in China, but we had broad-based growth in these geographies, including double-digit growth in India. Let me spend a couple minutes on China, which as you know is our largest market outside the U.S. Our team has consistently grown our business there faster than the market. We had another strong quarter in China in Q4 and that led to 20% growth for the year.

I like that the company is positioning itself in these emerging markets. They provide further growth opportunities since these regions are less developed but are catching up with the traditional western markets. Also India and China have enormous populations and while there will naturally be competition these markets are large and would more readily absorb the competition.

Marc Casper added,

We continue to increase our scale and depth of capabilities in China to meet the needs of our customers, and we’re excited about the opportunities we have going into 2019.

Considering that China is Thermo Fisher’s largest market outside of the United States, I think it’s a good move by management to pursue this market as there’s significant potential to boost its future earnings growth.

As for India, the Indian government wants to turn the country into a worldwide leader in the drug manufacturing industry. This will directly benefit Thermo Fisher’s as they provide many of the instrumental equipment used within the drug manufacturing industry.

I think that Thermo Fisher is well placed for future growth. The company is proactive and will divest business units if they underperform. Their future growth will come from their acquisition strategy along with their expansion into global markets.

Stock Valuation

Thermo Fisher has a solid history of growth and this growth is expected to continue heading into 2020. An appropriate method for valuing growth stocks is the PEG (PE divided by the earnings growth rate).

The historical earnings growth is 11.3 percent per year and its forecast 2020 growth rate is 16 percent per year. The average growth from 2014 until 2020 is 15 percent per year.

With a 15 percent growth rate this gives a forward PEG of 1.5 with a 2020 PE multiple of 22x.

It’s commonly accepted that a stock is fairly valued when its forward PEG is 1.0 which means that Thermo Fisher is overvalued with a stock price around $254. Its fair value would be around $170.

While Thermo Fisher is overvalued it’s not that expensive with a PE multiple of 22x for its 2020 estimated earnings and a book value of 3.7x.

Stock Price

As an active investor I personally like to determine some likely price targets. This gives me a feel for how high the stock price could go in the short term and how soon it could get there.

Thermo Fisher chart by StockCharts.com

The stock chart reveals that Thermo Fisher’s stock price has increased considerably over the last decade. From 2012 the stock essentially traded straight up to peak in late 2018. From there the stock pulled back along with stock market. Since the start of this year the stock has rallied to make a new high.

Should the stock keep rallying, in the short term it could replicate its 2018 advance where the stock ran up from $190 to peak at $250. This rally could be replicated in 2019 as long as the market continues to rally. The 2018 rally of $60 when added to the bottom of this year’s rally of $215 gives a target of $275 which could be reached by the end of the year.

Over the longer term the stock has the potential to continue higher and will probably do so as long as its earnings growth continues. In the short term Thermo Fisher could trade sideways for a year or so like it did back in 2011. Thermo Fisher’s strong stock price gains are attributed to its strong earnings grow over the years. Should its earnings grow slow in the future then I would expect its stock price to become volatile.

The stock market itself poses a risk. While its revenue and earnings were quite resilient during the last recession in 2008, its stock price did suffer with a significant decline during that period - having lost 45%.

The current bull market started in 2009 and is one of the longest on record. The market has rallied so far this year after a significant pullback late last year. If this rally fails and the market trades back down then there’s the real possibility that a new bear market has begun.

While Thermo Fisher’s revenue and earnings may be resilient, its stock price is not and in a bear market it would drop along with the market. However, due to its strong earnings growth it's stock price would recover quickly.

Conclusion

Thermo Fisher is a growth stock with a solid history of growth. The analysts are forecasting more growth heading into 2020. The company is proactive divesting underperforming business units and replacing them with new businesses that have more revenue potential. Also, the company is expanding its operations in emerging markets as a means of boosting growth.

Thermo Fisher is a profitable company that is well run with moderate debt levels. Over the long term I would expect the company’s earnings to continue higher along with its stock price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.