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In my May 19 post, I disclose a new Thermo Fisher Scientific (TMO) position in the FFJ Portfolio. On May 24, I published a brief post in which I disclose an increase in my TMO exposure.
I now hold 75 shares in a 'Core' account at an average cost of ~$509.61 and 52 shares in another 'Core' account at an average cost of ~$515.63.
Now that TMO has released its Q2 and YTD2023 results on July 26, I briefly revisit this holding to determine whether to acquire more shares.
Business Overview
I recommend reviewing Part 1, Item 1 in the FY2022 Annual Report and Form 10-K to gain a good understanding of the business.
The Corporate Overview on the company's website also provides a very high-level overview of TMO's FY2022 Revenue Profile.
CorEvitas, LLC Acquisition
On July 6, TMO announced it had entered into a definitive agreement to acquire CorEvitas, LLC, a leading provider of regulatory-grade, real-world evidence for approved medical treatments and therapies, from Audax Private Equity for $912.5 million in cash.
The transaction is expected to be completed by the end of 2023 and is subject to customary closing conditions, including regulatory approvals. Upon completion, CorEvitas will become part of TMO's Laboratory Products and Biopharma Services segment.
Financials
Q2 and YTD 2023 Results
Since TMO's Q2 2023 Form 10-Q is currently unavailable, I reference Q2 2023 Form 8-K and the GAAP and Non-GAAP Reconciliation and Financial Package.
Free Cash Flow (FCF)
In FY2013 - FY2022, TMO generated FCF of (in millions of $): 1,728, 2,192, 2,519, 2,814, 3,497, 3,785, 4,047, 6,815, 6,789, and 6,911. YTD cash flow from operations is $2.3B while YTD FCF is $1.537B, or $1.527B if we exclude $10 million in proceeds from the sale of property, plant and equipment; this is after $0.73B of net capital expenditures.
In Q2, TMO repaid $1B of senior notes and returned $0.135B of capital through dividends.
FY2023 Guidance
The financial performance of many companies in the Healthcare sector was artificially inflated by COVID-19-related income in FY2020, FY2021, and to a lesser extent in FY2022. It should not, therefore, be surprising if FY2023 results are weaker than in prior recent years.
In Q1, TMO's FY2023 revenue guidance was $45.3B, with 7% core organic revenue growth, and adjusted EPS guidance of $23.70. While there was no overall net change in TMO's guidance, how TMO expected to achieve this guidance differed from plans released at the beginning of FY2023.
Given the macroeconomic environment, TMO has now revised its FY2023 revenue and adjusted EPS guidance. It now expects 2023 revenue to be $43.4B - $44.0B, with Core organic revenue growth of 2 - 4%, and adjusted EPS of $22.28 - $22.72. For modelling purposes, the current estimate of where TMO expects to end up for the year within the sales range is $43.5B, with 3% core organic revenue growth, and $22.36 of adjusted EPS.
The revised guidance reflects a change in the assumption for core organic revenue growth and it also assumes a $0.1B lower testing revenue. The core organic revenue change is driven by:
- a reduction in the assumed level of economic activity in China; and
- an assumption that the more cautious spending across TMO's customer base in Q2 will continue throughout the remainder of FY2023.
At the beginning of the year, TMO saw positive momentum in the Chinese economy and assumed this momentum would continue through the rest of the year. As Q2 progressed, however, economic activity in China significantly slowed. Management now thinks it is appropriate to assume this weakness remains for the remainder of the year.
TMO's customers began the year with somewhat cautious spending given the uncertain macro conditions; this cautiousness increased in Q2. The previous assumption was that cautiousness would lessen as the year progressed. TMO now thinks it is appropriate to assume the cautious spending will continue through the remainder of the year.
TMO is using the Practical Process Improvement business system to aggressively manage its cost base. It put in place $0.45B of additional cost reductions to limit the impact of the expected lower revenue.
TMO now expects its FY2023 adjusted operating income margin will be 23.2% - 23.4%. This assumes the delivery of $0.3B of testing revenue in 2023 which is $0.1B lower than prior guidance. YTD, TMO has delivered ~$0.225B of testing revenue.
Management continues to expect $0.5B of vaccines and therapies revenue in FY2023. This is $1.2B less than FY2022. YTD, TMO has generated $0.365B of vaccines and therapies-related revenue.
In terms of adjusted EPS, TMO now expects FX to be a ~$0.11 headwind, which is $0.05 higher than previous guidance.
In early 2023, TMO completed the acquisition of The Binding Site Group. Within the FY2023 outlook is a ~$0.260B contribution from The Binding Site to the FY2023 reported revenue growth and $0.09 to adjusted EPS.
Expectations remain that FY2023 net interest expense will be ~$0.48B.
The adjusted tax rate assumption for the year has improved to 10% versus prior guidance at 10.8%. This is driven by TMO's tax planning initiatives.
The outlook calls for net capital expenditures of ~$1.7B and ~$6.9B of FCF in FY2023.
The guidance includes $3B of share buybacks which were already completed in January.
The assumption remains that the full-year average diluted share count will be ~388 million shares and that ~$0.54B will be distributed in dividends which is a 17% increase over 2022.
NOTE: Current guidance does not assume any future acquisitions or divestitures. In addition, no operational benefit in 2023 is accounted for from the acquisition of CorEvitas.
Credit Ratings
TMO's leverage ratios are the same as in Q1 and have deteriorated relative to recent fiscal year ends. TMO's leverage ratio at the end of Q2 was 3.2 times gross debt to adjusted EBITDA and 2.9 times on a net-debt basis.
Moody's, however, continues to assign an A3 rating to TMO's domestic unsecured long-term debt and the outlook is stable. This rating was upgraded in January 2022 from Baa1.
In June 2022, S&P Global upgraded its BBB+ rating to A- and the outlook is stable.
Both ratings are the bottom tier of the upper medium grade investment grade category. They define TMO as having a strong capacity to meet its financial commitments. TMO, however, is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
Source: TMO - GAAP/Non-GAAP Reconciliation and Financial Package - July 26, 2023
Source: TMO - GAAP/Non-GAAP Reconciliation and Financial Package - July 26, 2023
Source: TMO - GAAP/Non-GAAP Reconciliation and Financial Package - July 26, 2023
Fitch has not amended its rating since March 2021, when it upgraded TMO's domestic unsecured long-term debt to BBB+ from BBB. This rating is the top tier of the lower medium-grade investment grade category. This rating defines TMO as having an adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial obligations.
The maturity of the various financing arrangements is well structured and the Senior Fixed Rate Notes are attractively priced.
Dividend and Dividend Yield
TMO's dividend history is accessible here.
The dividend yield is negligible as the current quarterly dividend is $0.35/share and the current share price is ~$544.
I envision the bulk of TMO's future total investment return will continue to be predominantly in the form of capital appreciation.
On November 10, 2022, TMO's Board authorized the repurchase of up to $4B of the company’s common stock.
While the Q2 Form 10-Q is currently unavailable, we know that all of the shares repurchased by TMO during Q1 2023 were under this program. On May 5, 2023, authorization remained for $1B of future repurchases of common stock.
Source: TMO - Q1 2023 Form 10-Q
Average diluted shares amounted to 388 million in Q2 and is ~6 million lower YoY. This was driven by share repurchases, net of option dilution. It repurchased ~$3B (5.222 million shares) of its common stock in Q1 2023 and nothing in Q2.
Stock Splits
TMO had three 3 for 2 stock splits in the 1990s (1993, 1995, and 1996).
Valuation
In FY2013 - FY2022, TMO generated diluted EPS of $3.48, $4.71, $4.92, $5.09, $5.59, $7.24, $9.17, $15.96, $19.46, and $17.63. Its diluted PE levels were 30.67, 30.26, 28.83, 28.16, 32.24, 35.30, 36.54, 38.18, 30.98, and 30.96.
There is typically a wide variance between TMO's GAAP EPS and Adjusted EPS. Most of the variance is attributed to the amortization of acquisition-related intangible assets which is not surprising given the number of acquisitions TMO has made over the years.
Source: TMO - GAAP/Non-GAAP Reconciliation and Financial Package - April 26, 2023
At the time of my May 19 post, management's FY2023 adjusted diluted EPS guidance was $23.70. Using my ~$515 purchase price, the forward-adjusted diluted PE was ~21.7.
The forward-adjusted diluted broker estimates and valuation using my ~$515 purchase price were:
- FY2023 - 23 brokers - mean of $23.68 and low/high of $23.22 - $23.76. Using the mean estimate, the forward-adjusted diluted PE is ~21.8.
- FY2024 - 22 brokers - mean of $26.57 and low/high of $24.89 - $27.61. Using the mean estimate, the forward-adjusted diluted PE is ~19.4.
- FY2025 - 17 brokers - mean of $30.19 and low/high of $28.30 - $31.57. Using the mean estimate, the forward-adjusted diluted PE is ~17.
When I wrote my May 24 post, the broker estimates were similar. The valuation using my ~$507 purchase price was:
- FY2023 - 24 brokers - mean of $23.68 and low/high of $23.22 - $23.76. Using the mean estimate, the forward-adjusted diluted PE is ~21.4.
- FY2024 - 23 brokers - mean of $26.56 and low/high of $24.89 - $27.61. Using the mean estimate, the forward-adjusted diluted PE is ~19.1.
- FY2025 - 17 brokers - mean of $30.19 and low/high of $28.30 - $31.57. Using the mean estimate, the forward-adjusted diluted PE is ~16.8.
YTD GAAP EPS and adjusted diluted EPS amount to $6.83 and $10.18, respectively and the revised adjusted EPS guidance is $22.28 - $22.72 ($22.36 is what TMO is using for modelling purposes). Using $22.36 and the current ~$544 share price, the forward adjusted diluted PE is ~24.3.
Some brokers are likely still in the process of reassessing their guidance (most likely to the downside). The current forward-adjusted diluted broker estimates and valuation, however, are:
- FY2023 - 23 brokers - mean of $22.38 and low/high of $22.26 - $22.63. Using the mean estimate, the forward-adjusted diluted PE is ~24.3.
- FY2024 - 22 brokers - mean of $24.72 and low/high of $23.57 - $26.06. Using the mean estimate, the forward-adjusted diluted PE is ~22.0.
- FY2025 - 17 brokers - mean of $28.09 and low/high of $25.57 - $31.88. Using the mean estimate, the forward-adjusted diluted PE is ~19.4.
In FY2020 - 2022, there was a $3.60, $5.67, and $5.61 gap between GAAP EPS and adjusted diluted EPS. YTD, there is a $3.35 gap between GAAP EPS and adjusted diluted EPS. A sizable component of this variance is related to the amortization of acquisition-related intangible assets which does not impact TMO's cash flow.
I do not think TMO will generate $6.83 in diluted EPS in the second half of the year as it did in the first half. If it generates diluted EPS of $6.40 in the second half, then FY2023 diluted EPS will be ~$13.23. With shares trading at ~$544, the forward diluted PE is ~41.1. This is high when compared to TMO's historical valuation over the FY2013 - FY2022 timeframe.
Final Thoughts
On July 26, TMO's share price rose to ~$575. It has subsequently retraced to ~$544 as I compose this post. TMO's share price is ~$37 higher than my purchase prices in May yet the FY2023 outlook has been lowered!
Should TMO's share price retrace to the ~$510 I paid when I acquired shares, then the forward diluted PE is ~38.5 and the forward adjusted diluted PE is ~22.8.
I am looking to increase my exposure in companies that are facing temporary headwinds. However, I want to do so when shares become attractively valued. At the moment, TMO appears to be slightly overvalued despite the recent share price pullback. I would want to pay ~$510 or less given the lowered outlook.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long TMO.
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.
