Over the past two weeks, the price of Thermo Fisher Scientific Inc. (TMO, Financial) shares has dropped nearly $20, landing it on the Undervalued Predictable screener list at GuruFocus.
Appearing on this list is a mixed blessing for any company. It means the stock price has recently taken a beating of some kind, but the company also has the earnings power needed to get back on the upward track (theoretically, at least).
This three-month price chart shows the latest price action:
Thermo Fisher, a supplier to the scientific sector, has had a strong history of share price growth over the past decade, and that, along with its 5-Star predictability, suggests it will rebound.
Is this the kind of stock a value investor wants, or is it a growth stock temporarily in value land?
History
1902: Fisher Scientific founded to supply lab equipment, chemicals, supplies and other materials.
1956: Thermo Electron founded to provide analytical and lab products and services.
1967: A predecessor company makes an initial public offering.
1980: The predecessor’s shares begin trading on the New York Stock Exchange.
2006: Thermo Electron and Fisher Scientific merge into Thermo Fisher Scientific Inc.
2014: Acquisition of Life Technologies Corporation for $13.6 billion; Life operates in the fields of scientific research, genetic analysis and applied sciences.
2015: Acquisition of Advanced Scientifics for $300 million; it designs, manufactures and delivers technologies used in bioprocessing solutions.
2016: Acquires Affymetrix for $1.3 billion; the company is active in microarray technology and genomics analysis.
2016: Acquires FEI Company, a manufacturer of electron microscopes, for $4.2 billion.
History based on information at the company website and Wikipedia.org.
Thermo Fisher’s business
The company operates through five major brands (unless otherwise noted, the information in this section comes from Thermo Fisher’s 10-K for 2015):
- Thermo Scientific: Its primary product lines are high-end analytical instruments as well as laboratory equipment, software, services, consumables and reagents.
- Applied Biosystems: Major product lines are integrated instrument systems, reagents, and software for genetic analysis.
- Invitrogen: Consumables and instruments to speed up research and ensure consistency of results.
- Fisher Scientific: Provides a portfolio of laboratory equipment, chemicals, supplies and services used in scientific research, health care, safety and education markets.
- Unity Lab Services: The services brand, offers a complete portfolio of services from enterprise level engagements to individual instruments and laboratory equipment, regardless of the original manufacturer.
Operations are reported through four segments:
- Life Sciences Solutions.
- Analytical Instruments.
- Specialty Diagnostics.
- Laboratory Products and Services.
The Life Sciences Solutions segment was created in 2014, following the acquisition of Life Technologies.
About half of Thermo Fisher’s income originates in the domestic market, the other half from China, Germany, the United Kingdom and other countries.
Comments: The company is built around five brands, all of which serve the life sciences with products and services sold in America and other countries (most notably, China, Germany and the United Kingdom).
Revenue
Of the nearly $17 billion in reported revenue for 2015, the four segments made the following contributions (in millions):
- Life Sciences Solutions: $4,439.4.
- Analytical Instruments: 3,208.2.
- Specialty Diagnostics: $3,243.9.
- Laboratory Products and Services: $6,661.5.
American sales were $8.6 billion and as noted represent about half of the company’s sales in 2015. Otherwise:
- China: $1.4 billion.
- Germany: $900 million.
- United Kingdom: $800 million.
The following chart shows revenue growth over the past decade:
Note the bounce up for 2014 following the acquisition of Life Technologies Corporation.
Comments: Thermo Fisher generates revenue from a cluster of businesses focused on scientific products and supplies as well as complementary services. Growth of revenues has been slow and steady except for 2014, which reflects a major acquisition.
Competition
Thermo Fisher competes in the Medical Diagnostics & Research/Diagnostics & Research industry.
The company says its faces “aggressive and able competition” in all the diverse markets it serves. It reports, in its 10-K, that pricing is a low-level competitive issue. The three most important issues are:
- Technical: performance of existing products and innovations that generate better price/performance ratios.
- Product differentiation, availability and reliability.
- Depth of its capabilities.
Hoover’s lists its three main competitors as:
- Beckman Coulter Inc. (a subsidiary of Danaher Corp. [DHR]).
- Becton, Dickinson and Co. (BDX, Financial).
- Agilent Technologies Inc. (A, Financial).
As the following table from the Competitive Comparison page at GuruFocus shows, Thermo Fisher is the largest in both revenue and market cap:
Comments: An environment in which the ability to innovate, patent and develop new products gives large players such as Thermo Fisher opportunities to compete aggressively without margin concerns.
Moat
Morningstar sees Thermo Fisher somewhat protected by a narrow moat. It ascribes that moat to:
- The company’s size and the breadth of its product offerings.
- Frequently buying new businesses within its orbit so it also can market itself as a one-stop shop.
- The acquisition of Life to expand its consumables business, further locking in customers.
- Dominant product lines (most importantly, in expensive instrumentation, making customers relatively dependent).
In its research note, Morningstar says it hesitates to give Thermo Fisher a wide moat rating because it has a “lack of confidence in the company's ability to persistently generate returns on invested capital in excess of its cost, primarily due to its acquisition strategy.”
It also notes Thermo Fisher has used acquisitions to supplement its internal research and development. As acquisitions get bigger, the company may end up deploying capital in a value-dilutive manner.
The company says, in its 10-K, “We anticipate that we will continue to make significant expenditures for research and development as we seek to provide a continuing flow of innovative products to maintain and improve our competitive position.”
It also notes that while patents are important in every segment, it does not depend on any particular patent to the extent that its loss would have a significant effect on its operations.
Comments: Being big would appear to be its own reward when it comes to maintaining a competitive advantage. That’s being big and being able to use its size to cross-sell and cross-fertilize from segment to segment with newer technologies.
Growth
Guidance by way of the third quarter financial results included:
- Revenue: $18.25 billion to $18.39 billion (up 8% from 2015).
- Earnings per share: $8.19 to $8.30 (up 11% to 12% year over year).
At the May Analyst Meeting the company forecast for the next three years included:
- 4% to 6% organic growth.
- 12% to 15% adjusted EPS (earnings per share) growth.
- 12% to 13% adjusted ROIC (return on invested capital) growth.
The 2017 to 2019 Financial Model: Operational Performance Before Capital Deployment (also part of the 2016 Analyst Meeting presentation) calls for:
- Revenue 2019: $20.2 billion to $21.2 billion (representing a 4% to 6% increase, based on figures available at the time of the presentation in May).
- The model also anticipates an improved adjusted operating margin from 23.1% in 2016 to 25% in 2019.
Comments: A solid forecast from Thermo Fisher. But given its current size, and the size it will be if it continues to make acquisitions, can a bigger Thermo Fisher continue to grow at accelerated rates?
Other
Thermo Fisher Scientific is headquartered in Waltham, Massachusetts.
It had about 52,000 employees at the end of 2015.
Its year end is Dec. 31.
Chairman (independent): Jim Manzi, age 64, has held the position since 2007.
President, CEO and Director: Marc Casper, age 48, has been the CEO since 2009.
Chief Financial Officer, Senior Vice President: Stephen Williamson, age 49, has held these positions since 2015 (information about officers from Reuters.com).
Ownership
Among the gurus followed by GuruFocus, 19 have positions in Thermo Fisher. The biggest belongs to PRIMECAP Management (Trades, Portfolio), with 5,204,870 shares; that provides a 1.32% piece of the company. The second and third largest are the Vanguard Health Care Fund (Trades, Portfolio) and Larry Robbins (Trades, Portfolio).Ă‚
Turning to overall ownership, we see an overwhelming presence by institutional investors:
At the top of the insiders list is Paul M. Meister, a former chairman of Thermo Fisher and former vice chairman of Fisher Scientific International (before it merged with Thermo). He’s followed by CEO Marc Casper, who owns 266,597 shares.
Comments: With a high level of institutional ownership, a low level of short sellers, and commitment by senior officers this seems a safe company.
By the numbers
Comments: Current price is closer to the 52-week low than the 52-week high; small dividend; and small share buyback. Indications are strong that this a growth company.
Financial strength
Thermo Fisher receives a mediocre 5 out of 10 for financial strength and a strong 9 out of 10 for profitability and growth:
The red icons next to the cash to debt ratio and interest coverage indicate this company has a heavy, or at least relatively heavy, debt load.
That is confirmed by this 10-year chart of long-term debt:
To express that debt in another way, here is long-term debt at year-ends and for the trailing 12 months:
- Dec. 31, 2010: $2.031 billion.
- Dec. 31, 2011: $5.755 billion.
- Dec. 31, 2012: $7.031 billion.
- Dec. 31, 2013: $9.500 billion.
- Dec. 31, 2014: $12.352 billion.
- Dec. 31, 2015: $11,474 billion.
- Trailing 12 months (ttm): $16,940 billion.
Turning to revenue, the following chart (with an estimate for fiscal 2017 and 2018) shows revenue is expected to grow from $3.7 billion in 2006 to $20.8 billion in 2018, a better than fourfold increase:
Earnings per share has also grown over this decade (shown below, on the red line, along with long-term debt on the green line):
The free cash flow situation looks healthy over the same 10 years:
Comments: Over almost six years, long term has ballooned from just over $2 billion to nearly $17 billion. Revenue, earnings per share and free cash flow have grown robustly as well. Again, strong indications this is a growth, rather than value, company.
Valuations
Thermo Fisher belongs to an elite group of stocks, those with 5-Star (out of 5) ratings for predictability of earnings. That means it is more likely than non-5-Star stocks to provide a capital gain in the future and less likely to experience a capital loss. If it consistently increases it earnings, then the share price should follow, although the price path might be bumpy at times.
Turning to current valuations, the first comes from the DCF (Discounted Cash Flow) calculator, which puts the current price in overvalued territory:
Turning to the price-earnings (P/E) ratio, note that over the past five years (shown in the following chart) it climbed out of the mid-teens and got as high as the mid-30s. Since then, it has pulled back, to fluctuate in the mid- to high 20s:
The same sort of dynamic shows up in this five year chart of the PEG (P/E divided by earnings growth) ratio. After getting well into overvalued territory in 2013, it has since pulled back into the middle of the fair-valued range:
Writing in Barron’s on Nov. 12 2½ weeks ago, Jack Hough opined that Thermo Fisher had a 30% upside from the then-current price of $151.25; that would produce a price of $196.62. He notes the firm has beaten analysts’ estimates for 20 quarters in a row, and with annual research and development spending of $700 million a year, profit could climb nearly 60% in the next four years.
The analysts followed by NASDAQ.com have a 12-month consensus target of $175 for Thermo Fisher, which would be a nearly 25% increase over the closing price on Nov. 28. Most have a strong buy recommendation on the stock:
Comments: Valuations come in below and above the current price, but with a 5-Star predictability rating for consistency in earnings growth, it would seem safer to bet on higher rather than lower share prices.
Conclusion
This article began by questioning whether Thermo Fisher should be considered a value stock. It does appear on the Undervalued Predictable screener list, and certainly fits the profile of a predictable stock, one able to consistently grow its earnings.
But several pieces of data suggest the undervalued half is not a fit: a small dividend and little share buyback activity; robust growth on the top and bottom lines; and most importantly, increasing long-term debt.
No doubt the debt has made growth of revenue and earnings possible, but debt is also at a level that would concern conventional value investors.
In short, Thermo Fisher Scientific may only suit aggressive value investors who want to buy growth at what is likely to be a temporarily discounted price.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
Start a free seven-day trial of Premium Membership to GuruFocus.
