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Investors have so many companies in which they can deploy their hard-earned income yet many investors invest in terrible companies. This is truly unfortunate. My recommendation is that investors look to invest in wide-moat, rapid growth, and reasonably/attractively valued high-quality companies. I believe Thermo Fisher Scientific Inc. (TMO) is a rapidly growing wide-moat company worthy of analysis.
As Warren Buffett advises....“It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
This article looks at Thermo Fisher to determine if we should acquire shares now or wait for a more attractive valuation.
Business Overview
Thermo Fisher is a world leader in serving science. You can learn more about the company from this 2-minute video.
The company's Mission is to enable customers to make the world healthier, cleaner and safer. Its customers engage in:
- accelerating life sciences research;
- solving complex analytical challenges;
- improving patient diagnostics and therapies; or
- increasing productivity in their laboratories.
The global team is more than 80,000 colleagues who deliver innovative technologies, purchasing convenience, and pharmaceutical services through the company's industry-leading brands, including Thermo Scientific, Applied Biosystems, Invitrogen, Fisher Scientific, Unity Lab Services and Patheon.
A comprehensive overview of the company can be found starting on page 3 of 153 in the FY2020 10-K.
Page 12 of 14 of the company's February 1, 2021, GAAP/Non-GAAP Reconciliation and Financial Package shows has a schedule of the company's 2017 - 2020 Significant Acquisitions/Divestitures.
Financial Review
Q4 and FY2020 Results
As the premier life science supplier with an unmatched portfolio of products, resources, and manufacturing capabilities, Thermo Fisher was among the first to market with a reliable coronavirus test. The COVID-19 pandemic essentially reaffirmed its entrenched and dominant positioning with the supply chain.
I encourage you to review the Q4 and FY2020 results. Included with the Earnings Release is a comprehensive GAAP/Non-GAAP Reconciliation and Financial Package.
Many companies have struggled in arguably one of the worst years economically in history. Thermo Fisher, however, delivered its best year ever despite challenges around the economy and spending budgets; annual revenue increased ~$6.7B to $32.218B in FY2020 relative to FY2019. The company's impressive growth is further put in perspective when we compare FY2020 Revenue of $32.218B versus $11.726B in FY2011.
Diluted EPS from continuing operations and Net Income in FY2020 were $15.96 and $6.375B versus $2.65 and $1.33B in FY2011.
Thermo Fisher has been a prolific acquirer of companies over the years. This has resulted in Acquisition-related Intangible Assets increasing to ~$12.685B in FY2020 versus ~$7.816B in FY2011. Goodwill has also ballooned to ~$26B in FY2020 versus ~$12B in FY2011.
Investors should expect Thermo Fisher to remain acquisitive, with leverage between low-3x and more than 3.5x which is its long-term leverage range.
The company has spent aggressively over the years on internal efforts and on acquisitions in its quest to ultimately be THE one-stop-shop provider of life science instruments and consumables. It has deployed more than $30B since 2010 on this strategy. This has been accretive to its reach, scale, and product breadth. It has, however, historically suppressed returns on invested capital (ROIC) as evidenced from FY2011 - FY2020 levels: 7.4%, 6.24%, 6.01%, 7.32%, 6.4%, 6.31%, 6.37%, 7.35%, 8.74%, and 13.13%.
FY2021 Financial Guidance
Revenue
On the February 1, 2021 Earnings Call, management indicates the dynamics around the pandemic continue to be fluid but the company is well-positioned. Furthermore, its aggressive investment program will continue for near/long-term growth opportunities.
In the FY2021 guidance, the COVID-19 response revenue is more significantly weighted to the first half of the year; the guidance assumes COVID-19 testing demand may begin to moderate in Q2 and potentially moderate further as the year progresses. If the pandemic is longer-lasting and the need for testing is maintained this could be a sizable upside, particularly in Q3 and Q4. For now, however, management expects ~54% of FY2021's adjusted EPS guidance of $21.62 to occur in the first 2 quarters and 46% in the second half. Expectations are that Q1 organic growth and operating margin will be similar to Q4 2020.
FY2021 Revenue guidance of $35.1B, or ~9% growth over FY2020, includes 7% organic growth. The COVID-19 response is expected to contribute $7.1B which reflects testing-related revenue roughly the same as in FY2020 plus ~$1B of vaccine and therapy-related revenue in 2021 which is double the FY2020 level.
Thermo Fisher has a capacity to manufacture 20 million COVID-19 test kits per week. The benefit of COVID-19 test kits is expected to fade as the year progresses. The firm, however, should still see a material benefit from vaccine development efforts. It is anticipated the contract manufacturing business will become a solid growth component as vaccine manufacturing efforts accelerate globally.
Some analysts anticipate FY2022 to be growth-challenged as the company will face steep FY2021 comparisons and full vaccination. Revenue, however, is not expected to decline entirely to prepandemic revenue levels. Thermo Fisher's successful execution and further entrenchment and share gains during the pandemic are likely to remain.
Other
Forecast diluted adjusted EPS of $21.62 is ~11% growth over FY2020.
The projected net interest expense of ~$0.47B is ~$20 million lower than in 2020 due to lower average net debt. This guidance includes the impact of the $2.6B debt reduction in January 2021.
Net CAPEX guidance is ~$2.2B - $2.4B. The mid-point represents an increased investment of $0.8B versus FY2020. This is driven by capacity and capability expansions in the following lines of business:
- Pharma Services;
- BioProduction;
- Biosciences; and
- Laboratory Products.
The guidance includes $2.8B of capital deployment of which $1.5B will be share buybacks (completed in January 2021), $0.88B for the recently completed acquisition of Novasep's European viral vector business, and ~$0.4B of capital returned to shareholders through dividends. FY2021 average diluted share count will be ~398 million shares. Thermo Fisher's guidance does not assume any future acquisitions or divestitures including the acquisition of Mesa Biotech, which was completed in late February 2021.
Free Cash Flow (FCF)
I pay particularly close attention to FCF as this provides management with options to enhance shareholder value in the form of:
- debt repayment;
- dividends;
- share repurchases.
FY2021 Free Cash Flow (FCF) guidance is ~$7B. The increase from FY2020's FCF of $6.823B is primarily driven by earnings growth that is partially offset by a capital expenditures increase.
By way of comparison, FY2017 - FY2019 FCF is $3.505B, $3.835B, and $4.08B. The extent to which the company's growth has translated into FCF growth is evident when compared to the FCF of ~$1.424B in FY2011.
Risk Assessment
Investors should analyze an investment from a risk/reward perspective. I, therefore, include a review of the company's credit ratings from the major credit rating agencies. These rating agencies rate debt and my equity investments carry more risk. This is why I strongly favour investment-grade companies.
Looking at Note 10. Debt and Other Financing Arrangements on page 76 of 153 in the FY2020 10-K we see that Thermo Fisher has definitely taken advantage of the low-interest-rate environment to assist with its rapid expansion.
Page 11 of 14 of the company's February 1, 2021, GAAP/Non-GAAP Reconciliation and Financial Package has a schedule of the company's debt for the FY2017 - FY2020 timeframe.
Thermo Fisher's unsecured long-term debt ratings are:
- Moody: Baa1 - rated March 1, 2019 and affirmed March 3, 2020.
- S&P Global: BBB+ - rated May 1, 2018 and last reviewed September 2020
- Fitch: BBB+ - upgraded March 1, 2021
All three ratings are identical, are the top tier of the 'lower medium grade' category, and view an obligor to have ADEQUATE capacity to meet its financial commitments. Adverse economic conditions or changing circumstances, however, are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.
These ratings are satisfactory for my prudent investor profile.
Dividends and Dividend Yield
Investors should focus on capital gains potential from their Thermo Fisher investment because the dividend yield is negligible.
Although the company announced an ~18% increase in its quarterly dividend from $0.22/share to $0.26/share on February 23, 2021, the dividend history reflects prolonged periods in which the quarterly dividend is not increased.
The weighted average number of issued and outstanding shares in FY2011 - FY2020 (in millions) was: 385, 367, 366, 402, 402, 397, 398, 406, 403, and 399.
As noted above, Thermo Fisher completed a $1.5B share-buyback in January 2021.
Valuation
As noted above, dividend income from Thermo Fisher is going to be of little help in achieving financial freedom. This is why an attractive valuation is necessary.
On February 1, 2021, management provided FY2021 diluted adjusted EPS guidance of $21.62. With shares currently trading at ~$445, the forward adjusted diluted PE is ~20.6.
FY2021 guidance from 24 brokers is currently a mean adjusted diluted EPS of $22.04 and the low/high range is $21.55 - $23.92. Shares trade at ~$445 giving us a forward adjusted diluted PE range of ~18.6 - ~20.65.
Page 17 of 14 of the company's February 1, 2021, GAAP/Non-GAAP Reconciliation and Financial Package has a Quarterly Reconciliation of GAAP to Adjusted P&L in FY2019 and FY2020. Every quarter there is ~$0.75 - ~$0.85 of Amortization of Acquisition-related Intangible Assets, Net of Tax. There are other adjustments but this quarterly recurring charge is the largest. If we use $0.82/quarter we get an annual figure of $3.28.
Deduct $3.28 from the mean $22.04 adjusted diluted EPS guidance and the forward diluted EPS is ~$18.76. By way of comparison, FY2011 - FY2020 diluted EPS was $3.46, $3.21, $3.48, $4.71, $4.92, $5.09, $5.59, $7.24, $9.17, and $15.96.
Divide the current ~$445 share price by ~$18.76 and we get a forward PE of ~23.72. By way of comparison, Thermo Fisher's FY2011 - FY2020 PE levels were: 16.78, 18.59, 30.67, 30.26, 28.83, 28.16, 32.24, 35.30, 36.54, and 38.18.
Thermo Fisher's valuation is more attractive than in recent years. My concern is if interest rates start to rise, a broad market pullback is not an unrealistic expectation. I intend to initiate a position in Thermo Fisher at a share price closer to ~$410ish. I have arrived at this price using ~$18.76 in forward diluted EPS and a ~22 PE. Naturally, the purchase of Thermo Fisher shares is subject to funds availability and other future investment opportunities.
Conclusion
Thermo Fisher is a rapidly growing wide-moat company that has experienced a significant uplift from COVID-19 tests and vaccines. The swiftness and extent of its response have cemented its integral role with large pharma clients who see sizable benefits in the simplified procurement process Thermo Fisher offers. Because of the COVID-19 pandemic, the company's critical supplier status now includes governments. I expect Thermo Fisher's penetration of all its customer channels will continue to grow. Its already strong presence within rapidly growing emerging markets should also expand.
Thermo Fisher is certainly an attractive company. I will initiate a position should the FY2021 forward diluted PE retrace to ~22 or below. Based on:
- management's FY2021 adjusted diluted EPS guidance;
- the adjustments I made within the Valuation section of this article;
a ~$410ish share price is a level at which I would consider initiating a position.
Stay safe. Stay focused.
I wish you much success on your journey to financial freedom.
Disclosure: I do not hold a position in TMO and currently do not intend to acquire shares within the next 72 hours.
Disclosure: I disclose holdings held in the FFJ Portfolio and the dividend income generated from these holdings. I do not disclose details of holdings held in various tax-advantaged accounts for confidentiality reasons.
Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.
