Agilent Technologies (NYSE:A) has been refocusing on high-growth areas such as pharma, clinical diagnostics, and life sciences research. This is being reflected in the results, for example, in 2022 Agilent delivered impressive 12% core growth on top of 15% in the prior year. The company also saw margins improve by 160 basis points and its earnings per share grew 20% on top of the 32% growth of the previous year.
Since 2015, Agilent has implemented a model to drive above-market growth, expand operating margins, and deploy capital in a balanced manner. This has led to double-digit earnings per share growth. Agilent has been able to accelerate its growth rate and improve its margins by 800 basis points since 2015. The company aims to continue this trajectory by targeting 5-7% core growth, expanding operating margins by 50-100 basis points per year, and deploying capital in a balanced manner. All of these should result in a continuation of double-digit EPS growth.
Agilent is also committed to using its strong balance sheet to drive investments for growth as a top priority. This includes organic investments in CapEx, such as for expansion of the Nucleic Acid Solutions division (NASD). It has also shifted its portfolio to focus on more resilient, recurring revenue sources. The company’s pharma segment now makes up nearly 40% of total revenue, compared to 10-15% in 2015. Additionally, the energy segment, which was once 30% of the Chemicals and Advanced Materials segment, now makes up less than 2% of Agilent’s total revenues. The company is also seeing growth in new markets such as battery testing and semiconductor testing, which are expected to be more resilient due to government funding and public support for these initiatives. Agilent believes that these trends will continue in the future and will help it sustain growth.
Agilent has deployed over $3 billion in capital for M&A fiscal since year 2015. They are targeting great companies in fast-growing end markets. An interesting fact is that over 8% of Agilent’s revenues today have come through acquired companies.
During a recent investor conference the company was asked about a potential large acquisition, maybe of a public company, and this is what CEO Michael McMullen said:
[…] we have the ability to do larger deals relative to — our till date was the BioTek acquisition, but we have really strict parameters in terms of how we think about M&A, both in terms of maintaining investment grade.
It’s got to be accretive. It’s got to be the right kind of deal that we can make it work for our customers. I mean, excuse me, our shareholders as well as customers. What I would say is — I realize that this is an interesting microphone. OK. Sorry about that. I think the areas that we have been investing in, you’ve seen us do deals, cell analysis, genomics and diagnostics, they still remain the priority areas for the company.
As a result of operating leverage Agilent’s finances continue to improve, and the company now has an enabling ~25% operating margin.
The company’s return on capital employed is also increasing, and it is now at a very healthy ~18%. This should allow for an attractive compounding of retained earnings.
Revenue growth has averaged ~7% since 2015, but it has accelerated in recent years. What we find most attractive about Agilent’s growth is that the company has been able to grow at a rapid pace while improving profitability at the same time. In other words, the company has managed to deliver operating leverage as sales increase.
Despite debt rising in absolute terms, leverage has been coming down thanks to profits increasing rapidly. The company has more than a billion dollars in cash and short-term investments that should allow it to continue making attractive bolt-on acquisitions and to continue investing in its growth and R&D initiatives.
Agilent is very committed to sustainability in its own operations and in helping its customers meet their sustainability goals. The company has a plan to achieve net-zero emissions by 2050, and since 2014 has seen a 34% reduction in greenhouse gas emissions. Agilent also designs its instrumentation to be smaller and more energy-efficient and has a refurbished business unit that recycles and resells instruments to other customers. Additionally, Agilent’s CrossLab Connect helps customers reduce their energy consumption in laboratories. CrossLab is now a $1.5 billion business with ~60% of those revenues from annual or multiyear service agreements.
Agilent shared guidance for fiscal year 2023 in its last earnings call. For the full year, they’re expecting revenues of $6.9 billion to $7 billion, which represents core revenue growth of 5% to 6.5%, and they are guiding for EPS of $5.61 to $5.69.
The company mentioned that they have strong visibility into the first half of the year, and although the second half is more uncertain they are not seeing anything in the market that would suggest a slowdown either.
We are updating our rating to ‘Hold’ from ‘Buy’ due to a significantly less attractive valuation compared to the last time we covered the company. The EV/EBITDA ratio is now about five turns above the ten year average.
At current prices, we believe shares can deliver ~6-7% annual returns for long-term investors, which might be enough for some, but we would wait for a more attractive valuation before starting a position. Based on what we estimate future earnings to be, we calculate a net present value of ~$116 when using a 10% discount rate.
|EPS||Discount @ 10%|
|Terminal Value @ 4% terminal growth||214.49||68.34|
We believe Agilent has become a very resilient company, with a strong balance sheet, a high Altman Z-score, and significant recurring revenue. The main risk we see for investors, however, is a relatively high valuation. As such, we believe even a small disappointment with the company’s performance in the future could result in a meaningful price correction for the shares.
Agilent Technologies has been successfully refocusing on high-growth areas such as pharma, clinical diagnostics, and life sciences research. The company has a strong track record of driving above-market growth, expanding operating margins, and deploying capital in a balanced manner. The company is also committed to using its strong balance sheet to drive investments for growth as a top priority and has shifted its portfolio to focus on more resilient, recurring revenue sources. A significant portion of revenue is now recurring, and the company currently has a very large services business. Unfortunately the valuation is now very rich, and for that reason we are changing our rating to ‘Hold’.