- Waters operates in the highly attractive life science tools market. Target markets include pharma, biomedical research, clinical, food & environment, and material sciences.
- The company is undergoing a turnaround with the new CEO improving operations and more focused on reigniting growth.
- The company has a wide moat, earns high returns on capital, and operates with very high-profit margins, but shares are currently very expensive.
Waters Corp (NYSE:WAT) is an attractive laboratory equipment company that operates in several markets including pharma, biomedical research, clinical, food & environment, and material sciences. Most of these markets are growing at mid-single digits.
We consider Waters to have a strong business 'moat' thanks to switching costs. Customers would have to learn how to operate new complex tools, with potential small variations in the results, and companies doing advanced research want to minimize such risks. Another source of business moat comes from intellectual property, in the form of patents and trade secrets related to the equipment functionality.
Source: Waters Corp. Investor Relations
Another attractive characteristic of Water's business is that a significant part of revenue, around 17%, comes from consumables, which tends to be a very reliable source of recurrent revenue. Similarly, a good portion comes from informatics and services, which are also recurrent, meaning that all together ~55% of its revenues are recurrent.
The company has good geographic diversification, with the US at 29%, followed by Europe at 26%, China at 18%, Asia Pacific ex-china at 22%, and other at 5%.
Source: Waters Corp. Investor Relations
While the business has been very profitable, its growth was lagging behind that of competitors such as Thermo Fisher Scientific (TMO) and Agilent (A) in several areas. This prompted Waters to launch efforts to reinvigorate the business and reignite growth. The company has been open in saying that the loss of momentum in recent years was due to weak execution and a portfolio not aligned with the faster growth segments.
To fix this weak execution the company is focusing on gaining market share in instruments, and increasing the attachment rates for recurring revenue streams. It will also focus on increasing exposure to the faster-growing segments and improving its e-commerce platform.
During the last earnings call, there was a question on how the new initiatives are going to increase growth, and this is what the CEO Udit Batra responded:
Doug Schenkel[...] As we sit here today, based on the progress you've made and just cutting through the comps, are you comfortable asserting that Waters has built to compound revenue growth annually at 6% to 7% moving forward?
Thank you, Doug. I can't help, but laugh about the overall question, not that I'm making fun of the question, I just – it's a long – it's a serious progress in a year. But to answer your question legitimately, I would say it has to – if you look at the long-term growth, I won't give you a number. I think it's very difficult to do it. What you can safely assume is our ambition is to remain a top-tier performer, especially when you look at the organic growth, right. So we've now for the last two or three quarters on a stacked basis have been market plus and our margins remain at the high-end of the industry. So that's our ambitions, right. So, I mean, that's what I'll tell you. Is it 4%, 5%, 6%? I don't know, but if it's 4%, we have the ambition to be higher than 4%, if it's 5%, it's higher, and you can go on from there. But there are two drivers that make me confident, actually three drivers that make me confident that we can be at the higher-end of the market.
Number one, we've put a very solid team together with experienced leaders, who have shown in the past that they can execute very well above market – on the above market growth and they have experience in of course conducting transformations and integrations. So I feel very good about the team we've put together. Second, we're starting to develop a rhythm in our execution and you end up seeing the results, but we see a lot of leading indicators. And I've tried to give you some color around the different initiatives. And these are initiatives should – that should help us in longer-term. The LC replacement initiative has changed the way we work at Waters or probably brought us back to where Waters started long time ago, and looking at each and every replacement initiative and diligently going after through our CRM channel. That's a long-term improvement and execution.
E-commerce, last year, at the same time we were less – less than 20% of our consumables went through the e-commerce channel. Today that number is in excess of 25%, that's in less than a year. And there is a long runway ahead of us in seeing the benefit of that execution. We've started to tap into newer customer segments. And again, I mean, I was pretty open about how underweighted we were in the CRO, CDMO, food testing segments in China. And there we've just started to hit the side. And you can see on a two year stack basis that's 60% growth, on a one year stacked basis that's a 40% growth in the same channel. And we are seeing our value proposition resonate very well with our customers. Our sales teams are super excited about what we're hearing from our customers. So these – the execution platforms that we've built, and I've just gone through three of these are going to help us for many, many years to come.
And the last piece is innovation, which is most endearing to me. I mean, we have really been very precise about identifying unmet needs, and this is something definitely I don't take credit for. This has been going on at Waters for a long period of time. It was just starting to rekindle it and focusing us on the right problems to solve. We've seen already the impact of the recent launches in LC, the MRC is strengthening our high-res mass spec portfolio, the PREMIERE launch for the PREMIER – the PREMIER technology for columns as – could not have come at a better timing given the need for continued separation of more complex modalities, which have a higher affinity to metal. So I feel very good that there is a team in place that has a strong execution track record both organic and inorganic execution and the pipeline is starting to hit its stride. And I think that gives me confidence that wherever the market is, we can have the ambition to be a market class. Okay, I hope that gives you color.
Why it is a good business
Water has been growing revenue at a very quick pace in the last few years, and despite some hiccups during the Covid pandemic, revenue growth has quickly returned and it is now at a record.
Similarly, Waters has industry-leading operating margins, higher than peers Thermo Fisher Scientific and Agilent, although Thermo Fisher is closing the gap.
The company also has higher ROIC compared to these two competitors, and is above what most companies display.
Water has been returning capital to shareholders in the form of share repurchases, and we can see the number of diluted shares outstanding has significantly decreased over the last few years.
The one problem we have with Waters Corp, and the reason we don't own it, is that it is very expensive. The forward P/E ratio is ~33x and the expected P/E ratio in two years is still above 30.
Looking at other valuation measures we get a similar picture, with price/sales significantly above its 5-year median, at a very high value of ~8.3x.
EV/EBITDA is also quite high at 23x, despite the growth expectations and the financial improvement that should come from the turn-around efforts by the new CEO.
To get a more "normal" P/E ratio, we have to look all the way to FY2025 estimates, which give a FY25 P/E ratio of 22x.
Source: Seeking Alpha
Waters is an attractive company benefiting from two moat sources: switching costs and intellectual property. This has allowed the company to earn high returns on capital invested, and the company has benefited from significant growth in the life sciences sector. The company is making efforts to improve even further what it itself described as weak execution. These efforts together with a realignment of their products to serve the more attractive sectors should result in growing sales and earnings. We, therefore, agree with analysts that earnings will be growing the next few years, but find the current valuation multiples quite high. For the time being, we are just adding it to the watch list to buy during a stock market correction.
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