When I was young, I learned that the gold rush did not bring too much fortune to the gold miners but great fortune to the jeans makers. Waters seems to be a jeans maker in the health care and environmental protection gold rush.
Waters Corp. (WAT, Financial) is an analytical instrument manufacturer that primarily designs, manufactures, sells and services liquid chromatography (LC) and mass spectrometry (MS) technology systems and support products. The company’s products are used by life science, pharmaceutical, biochemical, industrial, nutritional safety, environmental, academic and governmental customers working in research and development, quality assurance and other laboratory applications. The other small part of its business is in categories such as thermo analysis (TA).
The company’s LC and LC-MS instruments are utilized in this broad range of industries to detect, identify, monitor and measure the chemical, physical and biological composition of materials and to purify a full range of compounds. These instruments are used in drug discovery and development, the analysis of proteins in disease processes, nutritional safety analysis and environmental testing.
Waters is somewhat like printer makers. Printer makers make and sell printers, then continue to make money from selling toner cartridges and services. Waters makes and sells LC and MS equipments and also the chemistry the equipments consume and service those equipments after warranties are over. The following table has the revenue spit. About 50% of revenue is recurring chemistry sales and services. Of course, these revenues depend on the sales of equipments. But still, the earnings are far more stable than equipment makers.
Waters has substantial sales from overseas. Asia now accounts for more than one-third of total revenue.
Waters was founded in 1958. Christopher O’Connell became CEO in 2015. He was a long-term executive at Medtronic (MDT, Financial) and had worked at Thermo Fisher Scientific (TMO, Financial). He has a bachelor’s degree from Northwestern University and an MBA from Harvard. Douglas Berthiaume, Waters’ ex-CEO from 1994 to 2015, is now chairman of the board.
Financial profile
Waters' ROIC is 40% and has been consistent over time. The company hasn’t had any acquisitions since the 1990s after it bought the TA business.
Waters' end markets are growing at 5% and above. Waters already has leading positions in what it does. Therefore top-line growth should be about mid- to high single digits on average. The growth will be a bit lumpy because of the timing of the product cycle as well as occasional significant movements in currency. But the fluctuation is small. Even in 2009, Waters’ revenue was down merely 5%.
Over the last several years, cost of goods sold and SG&A expenses came down as a percentage of sales. But R&D as percentage of sales went up. Overall margin has been increasing overtime. Margin improvements have been less significant in recent years. We expect net income roughly in line with top-line growth of mid- to high single digits.
As a result of strong cash flow generation, Waters has been constantly buying back shares. Shares outstanding was reduced 20% from 10 years ago. That is 2% to 3% per year.
Therefore, overall EPS should grow at about 7% to 10% on consistent basis.
Risks
The biggest risk is the existing technology in LC, MC and TA becomes obsolete. There is no reason to believe there is a foreseeable risk right now. That will not happen overnight, and there should be plenty of time to observe.
The second risk is that the company could not compete successfully. However, not only Waters is the leader in a fragmented market, but also it is increasing its R&D as a percentage of sales. It should be easier to maintain the current lead.
Currency is always a risk to Waters and has caused revenue volatility.
Valuation
Currently market looks expensive. Waters is selling at 20x 2017 earnings. Waters’ premium seems to have lowered compared to peers.
Against its peers, Waters does not appear expensive adjusted by its quality.
In brief, Waters is a well-managed company in a good business. Its revenue is 50% recurring and does not vary dramatically. The companies in this space are either very large like Thermo Fisher or small with a couple of billion dollars market cap. Waters is in a sweet spot. It is a leader in what it does. It can grow larger on its own with its ultrahigh ROIC and financial strength. Or it can be bought by the large companies. As a result, a premium valuation is warranted. Waters is an attractive long-term investment.
Disclosure:Ă‚ We have no position in Waters.
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