Thermo Fisher Scientific Inc. (NYSE:TMO) Morgan Stanley 21st Annual Global Healthcare Conference September 13, 2023 8:50 AM ET
Company Participants
Marc Casper - Chairman, President and Chief Executive Officer
Conference Call Participants
Tejas Savant - Morgan Stanley
Tejas Savant
Hey, everyone. Good morning. Welcome to Day Three of the Morgan Stanley Healthcare Conference. I'm Tejas Savant and I cover the Life Science Tools and Diagnostics sector at Morgan Stanley.
Before we kick it off, just some important disclosures. Please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, do reach out to your sales rep.
So it's my pleasure today to host Thermo Fisher. And from the company, we have Chairman, President and CEO, Marc Casper. So Marc, thank you for doing this.
Question-and-Answer Session
Q - Tejas Savant
Maybe just to kick things off, it's been a very dynamic environment for life science tools so far this year. As someone who's been in the industry for a long time now, can you talk to us about how you're thinking about the current dynamics?
Marc Casper
Tejas, thanks for having us here today. It's great to be in New York and see everybody in the ballroom. So this is my favorite conference of the year and I actually don't say that to everybody because it's good marketing, I guess. But 14 years ago, roughly to this day, I presented in the morning, and I got promoted to CEO in the evening. So it always has a positive place to my heart. In terms of the industry, I think in periods of transition and change, there's wonderful opportunities, right? And I always think about how do you navigate different environments in a way that you deliver really good short-term performance and you deliver moves that strengthen the company for the longer term. So I think everybody expected, coming into this year, that growth was going to moderate, right? And after several years of incredible growth in the industry, well above trend line, I think there was a view that things would return to more of a normal period. And every company define that differently. And the market's actually been slower than that. So and what's been the driver? I would say, the single biggest driver of what's going on is really the pandemic unwind on the economy, less so on what the pandemic unwind is on life science tools, diagnostics and pharma services, right? The higher interest rates, a less certain growth environment in GDP has led to definitely customer caution. You see it in the Chinese economy has been weaker. I'm sure we'll talk about that. And those macro factors clearly have weighed on the economy and also weighed on our industry. And growth has clearly been slower than what we've been certainly accustomed to over the last few years, but below trend line, if you take a look at the last 15 years or so. And from my perspective, that's a period where you have opportunities, right, to gain share and certainly to make moves to strengthen the company for the longer term.
Tejas Savant
Got it. Do you view these factors impacting the industry is structural or is this more of a short-term disruption?
Marc Casper
Yes. So I think it's a great question. It's one that I get a lot from investors. If you think about what's happened in the last two or three months, right, the news and terms structurally is really incredibly positive for the industry, right? You're seeing new classes of medicines get approved, right, whether it's for obesity. You're seeing progress on Alzheimer's. You're seeing vaccines for RSV. When that happens, there's more revenue for our client base that gets reinvested in R&D. Investors get interested in funding the newest and latest ideas and creates the positive momentum. That doesn't show up in the next quarter. But it's why we're so excited about what's going on long term in the industry, why we feel so good about it. The short-term challenges are -- they're real in terms of the market growth. And when I think about it, our original assumptions for this year was a 4% to 6% market growth, right? And when we came out of Q2, we said that the market growth is likely this year to be in the 0% to 2% range. And when I look at it, even six weeks after the guidance that we gave at our earnings call and read through all of the different analyst reports and so forth, I would say, at least six weeks later, you're probably trending at the lower end of that market range. And we won't know until December 31st, about year-end spend. That's probably the single biggest factor, whether you get higher in the range. But I would say, the conditions that we saw in Q2 continue with probably additional softening in China and certainly customer caution existing. So hopefully that gives you a sense of the long term. I think it's great the shorter term similar to challenged in terms of the conditions.
Tejas Savant
Got it. And just to put a finer point on that, Marc. In terms of the end-market dynamics that weighed on your first and second quarter results, how are you thinking about market growth for the third quarter and the full year?
Marc Casper
Yes. I would say for this would be flat to 2% is probably the market growth. Year-end spend will determine whether it gets to that 2% or is it going to be more of a flattish type year? I think that's the dynamic that we're in, with the first quarter being the strongest in our industry and sort of weaker in the balance of this year.
Tejas Savant
Got it. Switching to pharma and biotech. During 2Q, you noted that growth in the market was modest. Can you just elaborate on the factors leading to softer performance in the quarter? And the IRA is something that comes up in our investor conversations as well. Just wanted to get your view on that as well?
Marc Casper
Yes. So when I think about pharma and biotech, it's a terrific end market, right? And if you look at historically over the last 10-plus years, we've been gaining extraordinary share in serving pharma and biotech last year. We grew in the high teens serving that end market. And our expectation is, obviously, growth against that comparison. We're going to moderate substantially and is factored into our guidance. When I think about what we saw in the first half of the year, you clearly have a headwind in that segment from the roll-off on vaccine and therapy revenue. For us, in the second quarter played out exactly as we expected, right? We're on track to do $0.5 billion of revenue this year in supporting COVID vaccines and therapies. But that's still, even in the quarter, it was a five point headwind in pharma and biotech, right? So the math is just working our way through the comparisons. Pharma continues to be strong and the pre-revenue biotech kind of the emerging biotech definitely weaker as the funding window in the IPO market continues to be very modest. So you see that affecting customer caution in that customer base. Pharma continues to be good. And we're bullish about the long-term in pharma and biotech.
Tejas Savant
Got it. Switching to Pharma Services specifically and research. Despite more conservative spending at play and comments from peers around projects getting reprioritized, your business actually performed pretty well in 2Q and delivered double-digit growth. So why are these businesses proving to be more resilient despite the conservative spending patterns that some of the other peers are seeing?
Marc Casper
Yes. So Tejas, I think when you look at the two service-related businesses that we have, serving pharmaceutical and biotech, it's our clinical research business and it's our contract development and manufacturing business. Both businesses are growing -- grew double-digits in the quarter. And when I look at it, at a high level, those businesses generally operate off of activity that was generated in the quarters before, right? So you're running a predictable schedule. So that's -- we have had a very strong order book in both businesses. So you saw very strong growth. In Pharma Services, where we do the development and manufacturing, the business is performing at a great level. We are the leader in sterile fill finish, there's strong demand for that. We're winning significant business. The outlook is very strong. So that looks good. When I think about clinical research, where we're clearly benefiting from the revenue synergies from the acquisition of PPD, that's going really, really well. The business is performing at a very high level. Definitely, we've seen a slowdown in authorizations kind of new wins. So we would expect that the growth there moderates and will still be a business over time that grows faster than the company average. But we'll go from that sort of double-digit growth ultimately reverting back into the high single-digits over time.
Tejas Savant
Got it. And you sort of touched upon this, Marc, but the combined platform, can you talk a little bit about the differentiated value proposition that provides you with? And is that sort of translating into a degree of insulation as well?
Marc Casper
Yes. So when you think about the words that we use, the trusted partner status, right, it sounds good. So but what is it? We are the largest supplier partner pretty much to every single pharmaceutical and biotech company out there, right? And when you think about the decisions that those customers are making in working with us, they're just in daily contact, right? And we get insights into what are the challenges? Where do they need help? What are their priorities? And that allows us to bring the right capabilities, the right expertise to bear. And you see that when you disaggregate our company into the business lines, our business lines are growing meaningfully faster than the comparable peers, right? So it's not just that the company has a wonderful mix of activities that's growing really well, but that our individual businesses benefit from the strength of the company because customers are choosing to work with us. And so in areas like Pharma Services and Contract Development, our Fisher Scientific channel, these businesses have incredible momentum because of the value and the impact that they add to the customer base.
Tejas Savant
Got it. Switching to GLP-1, huge point of focus, obviously. Reuters recently reported that Novo hired you guys as a contract manufacturer for Wegovy. Can you talk about the broader opportunity that you see there? And to what degree could that be a meaningful tailwind for your services business?
Marc Casper
Yes. So when I think about the class of medicines the GLP-1's on obesity and diabetes, huge need across society. That will generate substantial revenue for the pharmaceutical industry. That revenue gets reinvested, if you will, into the ecosystem, which is why I'm so excited for the long-term. It's one class of medicines that will be significant and there'll be a number of others. For us, just that cycle of reinvestment in R&D benefits our tool business, the bioscience reagents, our lab products. It benefits our instrument business, it benefits the Fisher Scientific channel. That ecosystem that we fuel hugely benefits from the growth in R&D. At the same point, because of the role that we play on the manufacturing side, when you think about the sterile injectables there, we have scale and a leading reputation, outstanding quality track record. And we're excited to be able to serve our customers. And it's the type of class of medicine where we did a lot of activity for COVID vaccines. And as the demand there wanes, we always say we consider that core activity because the production lines are the same, right? So things like GLP-1s, we'll be able to backfill over time the volume that was consumed through COVID as an example. And that's a good thing. It's the natural transition of one medicine going out, another medicine coming in.
Tejas Savant
Got it. And that's actually a perfect segue into my next question. Where are you in that sort of transition today? And given the macro headwinds at play, do you think there's a risk of industry-wide overcapacity and perhaps margin pressure at least for certain niches like fill finish work where a lot of capacity was added?
Marc Casper
Yes. So Tejas, when I think about the role that we played in vaccines and therapies, but actually quite a broad role, right, which is, we did the sterile fill finish for vaccines. We produced therapies in terms of the active pharmaceutical ingredient. We did the clinical trials packaging and logistics in that phase of the process as well as provide the enabling technologies of purification enzymes in these products. This year, we expect to do about $0.5 billion of revenue in supporting vaccines and therapies. That's about $1.2 billion less than what we did in 2022. The year is playing out exactly as we predicted, anticipated and forecasted. We're at $365 million of revenue at the halfway point. And when we look into the contracts we have for the rest of the year that will bring us to the $0.5 billion. It's almost all fill finish activity. And when I think about 2024, I would expect that, that would be, I would assume, zero, although it will be a little bit larger than that, but I wouldn't assume a significant amount of COVID-related revenue. In terms of overcapacity for where we play not at all, right, because there's a huge shortage of sterile fill finish capacity in the marketplace. And yes there have been -- we've added lines and some others have added lines. But if you look at the momentum in biologics, our ability to transition that over time, we have high confidence.
Tejas Savant
Got it. Switching to China. Obviously, topic du jour. Economic disruption there is something that people have been talking about. Having recently come back from China, could you just give us an update on what you learned while you were there? Do you think that there'll be additional stimulus programs implemented this year? And what about the anticorruption crackdown?
Marc Casper
Yes. So Tejas, when I think -- I just got back. I spent late August in China. And I actually had two different lenses or roles that I played on the visit. I Chair the US China Business Council, which is the America's largest companies that work in China, an organization that's celebrating its 50th anniversary. And obviously I went as CEO of Thermo Fisher Scientific. So half of the trip was really interacting with government, chairing and leading a delegation, right? So I sat with Premier Li. I sat with a number of the heads of the various ministers, their leading economists, and just had a very cordial set of interactions, where it came away very clear that China is trying to reduce the friction from the business community, make it easier to do business and bring in reforms that will spur investment and growth. None of those things are going to happen tomorrow, but the direction of travel is to reduce the tension. And you could not have left those interactions, not coming away more positive than when you -- when we arrived, right? And that was -- and nothing surprise there, whether it was the formal or the informal, I came away encouraged. When I think about the economy and think about how the government is responding, the economy is definitely challenged. There's nothing profound in that statement. And it feels like there's a period of time that we're going to be through a challenged environment, right, which is government stimulus was not something that was talked about in the various interactions, because I think they're working through how do you deal with property valuations? How do you deal with government debt? So while stimulus may happen, it certainly wasn't the top-of-mind discussion that we had. When I pivoted to the Thermo Fisher Scientific side of what's going on in China, saw a number of customers, there's money out there, right? There's opportunities to grow. There's excitement for the mid and long-term. I believe that the mid and long-term for China, it's going to continue to be one of the fastest, if not the fastest-growing end market in our industry and for Thermo Fisher Scientific. It's not going to be a 15% plus end market. It's going to be a high single-digit 10% type growth market in the longer term would be my expectation. And the last thing I'd say about China is my expectation is that China will be challenged this year, right? So I think it will weaken based on the business sentiment and the lack of sort of immediate actions. I think that's a challenge. And I think things like anticorruption, huge positive for the multinationals, right? The cleaner the economy, the multinationals win, right? That doesn't mean that there won't be customers that are afraid to see suppliers, all of that dynamic. That's a couple of quarters, a quarter, whatever it is, but that's a huge positive for our industry to be able to compete on a level-playing field with local players.
Tejas Savant
Got it. That's actually super helpful. Do you envision Thermo Fisher having to do something different from your in-China, for-China strategy in light of what you learned on your trip?
Marc Casper
Yes. When I think about how we play today because of our scale, we have the largest presence in China. But as a percentage of our total, we're actually one of the companies with less exposure, if you will, right? It's -- we're probably in the 8% of our revenue, something of that sort. We manufacture in China for the Chinese market. So we have a series of manufacturing plants that produce for the local market. Probably 40%, 50% of our production comes locally and that served us well. We innovate in China for the Chinese market. We have a number of R&D centers and applications labs that do that. So we're quite local in terms of how we operate. And in the areas where we -- it makes sense to import mass spectrometers, things of that part. We've had no problem in terms of being able to navigate that environment.
Tejas Savant
Got it. One final question in China, and then we'll move on. One of the themes that we picked up from some of your peers is some local suppliers did get qualified over the course of the pandemic. And there's a portion of the user base there that's now sticking with them coming out of the pandemic. Is that a dynamic that you've encountered at all?
Marc Casper
Yes. I mean there's always local competition, has always been there. Clearly, during the pandemic when there were supply chain disruptions, I'm sure in certain categories, local competition picked up, other categories didn't. My take on the various reviews and dialogue, not just on the visit, but over the last few years with the China team, in aggregate, that hasn't changed a lot. That doesn't mean that there isn't some category where there is a stronger Chinese player. But I'd say has the landscape changed radically or in a way that it's less favourable nothing significant.
Tejas Savant
Got it. Great. Switching gears to capital deployment. You've done several acquisitions over the past couple of years including CorEvitas, MarqMetrix, Binding Site, PeproTech, et cetera. But given that your last large acquisition was with PPD back in '21, what is your appetite for a larger transaction today?
Marc Casper
Yes. So when I think about our M&A strategy, right, it's proven it's incredibly disciplined, right? Will the transaction create value? Will it be appreciated by our customers? Will it strengthen the company strategically, right? And when I think about size of transactions, actually, that one, I don't worry too much about, right? We've done very large transactions. We've done many bolt-ons. We'll look at both. And if the right large transaction is available, we'll do it. And if it's a series of bolt-ons that works as well. We look at many. We pass on most. And the ones that we do, we have an extraordinary track record of execution and creating tremendous value for our shareholders. And that discipline will continue. I love this M&A environment, right? Higher interest rates, a more uncertain world, there's a huge advantage for having a track record and experience and being able to understand the risk you're taking and the risks you're unwilling to take. And for us, this is a great time. We'll be super selective, but we're busy and looking at a number of different options.
Tejas Savant
Got it. I'm going to hit on a couple of end markets, and then we'll get to the forward-looking stuff, right. On analytical instruments, Marc, you've noted softer-than-expected orders here in the second quarter.
Marc Casper
Right.
Tejas Savant
China was certainly a large part of that. How are you thinking about balancing the near-term headwinds versus your continuous efforts to drive innovation? The Orbitrap Astral was one recent prominent example of that. Do you think that sort of is part of the growth algorithm for AI over the next couple of years?
Marc Casper
Yes. So if I think about one of the benefits that we had in terms of the large role we played in the COVID response, right? We played the leading role in the industry. We invested heavily in our Analytical Instruments business during that period of time, right? Unrelated to the COVID response but part of the reinvestment in the company was there. You see that in a stream of product launches, whether it's the Orbitrap Astral, which I think is the most profound mass spectrometer launched in the industry in a decade or the series of electron microscopes that we've launched. These products make a huge difference in an environment where capital is a bit more constrained. Customers always find capital for innovative products, right? Where they cut back is replacement fleets, right, and life cycle of the instrument. But where there's innovation, funding has always been out there. So we had a great first half, double-digit growth. When I look at orders momentum slowed, primarily driven by China. We would expect growth to moderate in the second half, which is what's embedded in our guidance. But in terms of the new products, they're being well adopted and that will be a nice tailwind and will continue to be a tailwind for us in 2024.
Tejas Savant
Got it. And switching to industrial and applied. Investors often associate that exposure with macro cycles. How true is that in Thermo's case? And can you talk through some of the recent trends you see in cyclical areas such as semis versus areas where there are secular growth, right, EV batteries, PFAS chemical testing, et cetera. How much of your exposure is those latter e-cyclical secular areas?
Marc Casper
Yes. So the company has changed a lot over the last 15 years, right? And today, industrial and applied is about 13% of our end market. It was about 30% back in that period of time around the financial crisis. So huge change. When I look at the end markets, semiconductor, where we are the leading provider of electron microscopes, that's our very narrow role, but a significant role, continues to be very strong, right? The next node, the new fabs, that type of spend, not about the number of chips sold is what drives it. There the investment rate has been very good. So we're seeing good growth. In terms of some of the new regulations, new concerns, things like PFAS, good driver of growth as well. So industrial and applied markets continue to be reasonable, right, from our perspective. Those that are purely economically sensitive will be more challenged, right? The typical QA/QC labs, the HPLC fleets where we don't play in a large way, but a little way, and molecular spectroscopy, some of those things, will have more headwinds.
Tejas Savant
Got it. Fair enough. One of the questions that we get and this is sort of going back to the capital deployment theme really is, has your thinking in terms of deal size or area of focus changed in light of more regulatory scrutiny from the FTC and perhaps the need for an elongated time frame to deal close that perhaps includes going through a court process if need be, how do you think about that?
Marc Casper
Yes. So in all deals, we look at the downside case, the risk that we're -- that we'd be taking on and what are the rewards for taking on the risks and that all factors into our decision making, right? And so we're well advised. We have a good experience base. And we factor it in, but each deal is specific. So we will look at it and make a decision on what's the right approach for a transaction.
Tejas Savant
Got it. Fair enough. What sort of leverage ratio are you comfortable with for the right transaction?
Marc Casper
We're going to maintain a strong investment grade. So we have very substantial capacity to be able to do transactions and embedded into our multiyear outlook. We have $50 billion plus type to deploy.
Tejas Savant
Got it. Turning to 2024. Can you just help us form an early view on that in terms of some of the knowns and the unknowns that we need to keep in mind?
Marc Casper
Yes. So when I think about 2024, right? And our plan is after we report Q3, we'll give some more color, right? We won't give guidance until January when we do our earnings call. But we'll give some more color based on the first nine months of the year to help for modeling purposes. The factors that I think you can assume is take our ending margins for the year, add 50 basis points on the margin, maybe a little bit more because some of the cost reduction carryover. So I think the margin side, I think, is straightforward and then weigh in the market growth assumptions that you believe are appropriate. Clearly, right now, the economy is certainly challenged. So that will be a headwind. The comparisons get a bit easier. So that's a tailwind relative to this year and we'll factor in the right level of outlook as we get -- as we see certainly how the year finishes up to set the right growth targets for next year.
Tejas Savant
Got it. In terms of your long-term algorithm, right, a lot of tools companies raise their long-term growth targets on the back of an extended period of robust growth in biopharma in China. Beyond the near-term headwinds in both of those end markets for very different reasons, what is your view in terms of how things play out in terms of the growth algorithm there? Do you think that the growth there -- you mentioned China sort of resetting from mid-teens to high single-digit, but what about biopharma?
Marc Casper
Yes. So when I think about the longer-term outlook, right, and I think this is one for investors. I think it's good to be reminded of where we are, right, which is we changed our outlook to 5% to 7% growth, right, in terms of the long-term. And what's embedded in that is long-term market growth of 4% to 6%. When you're in a tougher period of time, I think it's very natural to say, is that 4% to 6% a good assumption for the long-term or not? And based on my -- now it's closing in on 30 years' experience in the industry, actually, the 4% to 6% is a very reasonable assumption. You can be more conservative on China. You can make your assumptions on IRA or whatever you want to assume. But the noise level around the 4% to 6% is pretty minimal, right, on that. And if you look at the momentum that we have, our ability to grow faster than the industry is, I think, we have an extraordinary 7% to 9%. Almost 5% to 7%. Our outlook is 7% to 9%, sorry about that. This is panicking. So, Raf, it's sweating like it's -- so it's 7% to 9%, my apologies. We went from 5% to 7% to 7% to 9%. So our ability to grow at that rate, I feel incredibly positive about, right? And the interesting thing is that after we raised our outlook. Almost everybody else in the industry did, I love it, right? Like I don't know if they're going to achieve their growth outlook. I don't care actually. What I care about is our ability to do that. We have an extraordinary track record based on decades of creating value. And we're going to win, right? So I can't tell you what the next quarter is or sort of how to call exactly the bottom, but what I can tell you is we've created a structural advantage. And that's awesome and that will create a lot of shareholder value and we'll go out and execute well.
Tejas Savant
Got it. That's a great place to leave it at. So thank you so much, Marc. We appreciate it.
Marc Casper
Thanks, Tejas.
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