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The time to invest in great companies is when they fall out of favour. Buy Thermo Fisher Scientific (TMO) while it faces short-term headwinds.
I last reviewed TMO in this brief September 8 post. At the time, shares were reasonably valued at ~$514 based on earnings guidance.
On October 25, however, TMO released its Q3 and YTD2023 and revised FY2023 guidance. Results fell short of earnings consensus and guidance was lowered. This resulted in TMO's share price falling as low as ~$416. Unfortunately, I procrastinated and only ended up acquiring shares on September 13 by which time TMO's share price had recovered to ~$445.
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.
In addition, I reviewed material presented at TMO's 2023 Investor Day in my May 24, 2023 post.
Olink Holding AB Acquisition
On October 17, TMO announced it had entered into a definitive agreement to acquire Olink Holding AB, a leading provider of next-generation proteomics solutions. The transaction values Olink at ~$3.1B which includes net cash of ~$0.143B.
The transaction is expected to be completed by mid-2024 and is subject to customary closing conditions, including regulatory approvals. Upon completion, Olink will become part of TMO's Life Sciences Solutions segment.
Financials
Q3 and YTD2023 Results
Please refer to TMO's Q3 2023 Earnings Release, Q3 2023 Form 10-Q, and the GAAP and Non-GAAP Reconciliation and Financial Package.
Despite continuing broad market weakness, TMO delivered core organic growth in Q3 and a ~42% adjusted gross margin versus 41.7% in Q3 2022. This, however, falls well short of the 51.2% and the 51.6% adjusted gross margin in FY2020 and FY2021.
Adjusted operating margin in Q3 2023 was 24.2% versus 22.2% in Q3 2022. In comparison, TMO's operating margins in FY2013 - FY2022 were 12.89, 11.28, 14.45, 14.49, 14.61, 15.74, 16.37, 24.5, 26.08, and 18.94; TMO experienced a COVID-19-related windfall which led to FY2020 - FY2022 margins being well above historic norms.
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 FCF is $3.685B and management expects ~$6.7B - $6.9B in FY2023.
FY2023 Guidance
TMO continues to expect to grow faster than the market for the full year and to once again deliver market share gain in 2023. Factoring in the current macroeconomic conditions and an increase in FX headwinds, core organic revenue growth is expected to be just under 1%, revenue guidance is $42.7B (previously $43.4B - $44.0B) and adjusted EPS guidance is $21.50 (previously $22.28 - $22.72).
TMO's revised revenue guidance is $0.85B lower than the prior outlook of which $0.2B is driven by an increased FX headwind.
Net capital expenditures in FY2023 will be $1.3B - $1.5B.
FY2024 Guidance
On the Q3 earnings call, management stated:
At this point in time, a good starting assumption is that our core organic revenue growth in 2024 is similar to 2023, with ~1% growth. With our proven growth strategy, we expect to continue to take share, and that would mean market growth in 2024 will be similar to 2023 with the market declining 1 to 2 points.
In terms of phasing of our core organic revenue growth, it is best to assume a more challenging first half and then moderate growth in the second half. The pandemic-related revenues, both testing and total vaccines and therapies are likely to be ~$0.3B in 2024. This is a headwind of ~$1.3B or 3% of revenue. M&A is expected to increase revenue by ~$0.175B YoY. That's a combination of 6 months of Olink and the inorganic portion of the CorEvitas revenue in 2024. And based on current rates, we'd expect FX to be a headwind to revenue in 2024 of ~$0.375B, just under 1%.
So wrapping all this together, 2024 revenue dollars will be very similar to 2023.
Formal FY2024 guidance, however, will be provided at TMO's next earnings call.
Credit Ratings
Moody's continues to assign an A3 rating to TMO's domestic unsecured long-term debt with a stable outlook. This rating was upgraded in January 2022 from Baa1.
In June 2022, S&P Global upgraded its BBB+ rating to A- with a stable outlook.
On September 1, 2023, Fitch upgraded TMO's domestic unsecured long-term debt to A- from BBB+ with a stable outlook.
All three 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 - October 25, 2023
Source: TMO - GAAP/Non-GAAP Reconciliation and Financial Package - October 25, 2023
Source: TMO - GAAP/Non-GAAP Reconciliation and Financial Package - October 25, 2023
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. On January 16, 2024, TMO is scheduled to distribute its 4th consecutive $0.35/share quarterly dividend. I envision that it will declare a $0.04/share increase in its quarterly dividend in March. At $0.39/share/quarter and the current ~$445 share price, the dividend yield is negligible.
I envision the bulk of TMO's future total investment return will continue to be predominantly in the form of capital appreciation.
The weighted average diluted shares outstanding in FY2013 - FY2022 (in millions) were 366, 402, 402, 397, 398, 406, 403, 399, 397, and 394. TMO continues to assume the FY2023 average diluted share count will be ~388 million shares.
On November 10, 2022, TMO's Board authorized the repurchase of up to $4B of the company’s common stock. In Q1, TMO repurchased $3B (5.222 million shares) and there was no share repurchase activity in Q2 and Q3. On September 30, 2023, authorization remained for $1B of future repurchases of common stock.
Stock Splits
TMO had three 3 for 2 stock splits in the 1990s (1993, 1995, and 1996).
Valuation
When I wrote my August 2 post, TMO had recently reported YTD GAAP EPS and adjusted diluted EPS of $6.83 and $10.18, respectively. Its revised adjusted EPS guidance was $22.28 - $22.72 and TMO suggested analysts use $22.36 for modelling purposes. Using $22.36 and the current ~$544 share price, the forward adjusted diluted PE was ~24.3.
While some brokers were still in the process of reassessing their guidance, TMO's valuation based on the currently available forward-adjusted diluted broker estimates was:
- FY2023 - 23 brokers - a forward-adjusted diluted PE of ~24.3 using a mean of $22.38 and low/high of $22.26 - $22.63.
- FY2024 - 22 brokers - a forward-adjusted diluted PE of ~22.0 using a mean of $24.72 and low/high of $23.57 - $26.06.
- FY2025 - 17 brokers - a forward-adjusted diluted PE of ~19.4 using a mean of $28.09 and low/high of $25.57 - $31.88.
I also noted that there was a $3.60, $5.67, and $5.61 gap between GAAP EPS and adjusted diluted EPS in FY2020 - 2022. In addition, there was a $3.35 gap between GAAP EPS and adjusted diluted EPS in the first half of FY2023. A sizable component of this variance, however, is related to the amortization of acquisition-related intangible assets which does not impact TMO's cash flow.
I did not think TMO would generate $6.83 in diluted EPS in the second half of FY2023 as it did in the first half. I, therefore, arbitrarily assumed TMO would generate $6.40 of diluted EPS in the second half, thereby giving us ~$13.23 of diluted EPS in FY2023. With shares trading at ~$544, the forward diluted PE was ~41.1. I considered this to be high when compared to TMO's historical valuation over the FY2013 - FY2022 timeframe.
On September 8, I acquired additional shares at ~$514. Using the currently available forward-adjusted diluted broker estimates, I arrived at the following forward-adjusted diluted PE levels and considered TMO to be fairly valued:
- FY2023 - 26 brokers - a forward-adjusted diluted PE of ~23 using a mean of $22.38 and low/high of $22.26 - $22.64.
- FY2024 - 25 brokers - a forward-adjusted diluted PE of ~20.9 using a mean of $24.63 and low/high of $23.57 - $25.65.
- FY2025 - 19 brokers - a forward-adjusted diluted PE of ~18.4 using a mean of $27.93 and low/high of $25.57 - $31.88.
In Q1 - Q3, TMO generated $5.03, $5.15, and $5.69 in adjusted diluted EPS and $11.25 and $15.87 in YTD diluted EPS and adjusted diluted EPS. TMO's FY2023 adjusted diluted EPS guidance is now $21.50 meaning it needs to generate $5.63 in Q4. Given that TMO has lowered its earnings guidance in recent quarters, I think management has been cautious in setting its most recent FY2023 guidance. I, therefore, anticipate TMO will meet or slightly exceed $5.63 in Q4.
On November 13, I acquired 25 additional shares at ~$445. Using the currently available forward-adjusted diluted broker estimates, I arrived at the following forward-adjusted diluted PE levels and considered TMO to be fairly valued:
- FY2023 - 26 brokers - a forward-adjusted diluted PE of ~20.6 using a mean of $21.56 and low/high of $21.47 - $22.10.
- FY2024 - 25 brokers - a forward-adjusted diluted PE of ~20.2 using a mean of $22.04 and low/high of $21.70 - $25.71.
- FY2025 - 19 brokers - a forward-adjusted diluted PE of ~18 using a mean of $24.73 and low/high of $23.24 - $28.09.
Final Thoughts
COVID-19 is no longer a pandemic, and therefore, TMO no longer benefits from the windfall it experienced in FY2020 - FY2022. As a result, investors should not compare TMO's results with those generated a couple of years ago. TMO's current margins now more closely resemble those prior to COVID-19.
In FY2020 - FY2022, TMO generated GAAP consolidated revenues of ~$32.2B, ~$39.2B, and ~$44.9B. Without the benefit of COVID-19-related revenue, TMO still expects to generate ~$42.7B in FY2023 revenue. In addition, tight expense control has led to a ~200 - ~300 basis point improvement in gross margin relative to Q3 2022.
In several prior posts, I have expressed an interest in acquiring shares in great companies experiencing temporary headwinds that have fallen out of favour with the investment community. Based on my analysis, TMO faces short-term headwinds thereby making this an opportune time to invest in this industry leader.
TMO was reasonably valued when I previously acquired shares. Despite a ~$69 drop in the share price from when I purchased shares in early September, TMO's valuation based on adjusted diluted EPS estimates is relatively similar.
Were I not accumulating funds for a specific purpose, I would have acquired more than just the 25 TMO shares I purchased on November 13 at ~$445/share. I now hold 177 shares (52 shares and 125 shares in two different 'Core' accounts) in the FFJ Portfolio.
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.
