In spite of an upwelling of negative sell-side sentiment around Tools in the last 10 days, group multiples vs Healthcare (Exhibit 12) have hardly moved and remain at all-time highs +70% above; multiples vs the S&P are 1000bps lower in the last 10 days, at +55% vs historical norms at +10-40% (Exhibit 11). Datapoints from DHR and Sartorius (SRT) appear to be construed thus far by investors as an all-clear for 2Q and near term stock momentum.
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DHR raised the EPS guide 1-2% on core growth guidance +100bps, implying stable order momentum. We find the result encouraging given the macro backdrop, supporting a view that DHR positioning and commercial strategy are attractive vs Tools. We are increasing our 2019 EPS estimate by 3c to $4.90 on a lower interest expense forecast, as our higher revenue forecast is offset by higher expenses. We are lowering our PT to $166 from $172 on macro uncertainty. Our medium term estimates are roughly unchanged, as the bioprocess/GE outlook offsets near-term macro questions. Details in Exhibits 1-6.
With a full set of May data, we present an update to the Global Tools Momentum Indices (GTMI) we introduced in June. At the sector level, deceleration in the demand lead indicator series continues, with Industrial leading the way, more modest slowing in Applied and Government/Academic, and Pharma steady (with Bioprocess accelerating to offset small molecule choppiness). Our China index again signals slowing is likely; we believe China slowing was a component of the slowdown at ILMN. We outline trends in 19 graphs in this report. Our recent management discussions point to slowing in Europe, perhaps more acutely than in China.
We introduce new datasets on global discretionary demand (deteriorating), DTC competitors (accelerating), valuation (more favorable), and organic drivers in the model (slowing). The fundamental picture is less attractive than a year ago, but cautious commentary on China from ALGN during 2Q accelerated a pullback that has the stock down 40% vs fast-growth HC peers since mid ‘18 (Exhibit 1). There is now upside to our price target, though our PT assumes capital deployment and macro stability.
The ILMN guidance revision (-$250mn top line to +6% from +13.5% at midpoints) will leave questions regarding the possibility of a structural problem open through at least year-end for most investors. Our view is that the true underlying issue here is over-optimism in forecasting sizeable partner-driven revenue line items, and our confidence in the underlying shape of the sequencing uptake curve is unaltered by the news. ILMN clarified three items taking down the outlook for the year: 1) Weakness in DTC genomics driving an 1400bps downward revision in growth in Arrays, $78mn. 2) Major risk-adjustment to the expectation for $55mn in PopSeq articulated on the 1Q19 call, we estimate $45mn. 3) Delay to ‘20 of revenue from a key discrete clinical partner program, roughly $100mn+. Two of these three items are timing items, pushing $150mn (400bps) of clinical and Pop Seq sales into ‘20, and setting up a bigger growth year in ‘20. To be clear - this was not a signal of competitive pressure or i
Agilent has the lowest leverage in Tools with a net cash position, while the group has 0.6x EBITDA leverage on average, and closing the leverage gap is key to making the stock work medium term. While the BioTek deal announced this morning is nominally expensive at a net price of 5.9x 2019 sales and 22x F2019 EBITDA, Agilent has a history of taking 10% growth assets to 30% growth on 12 month horizons and BioTek and Agilent are already collaborating on integrated cell analysis workflows. We would prefer more accretion (the $0.02-$0.04 guidance for FY20 is conservative given it assumes no selling synergies) but the asset should drive 35bps of growth in ‘20 and 1%-2% accretion in ‘21.
Tools stocks are the most expensive vs. broader Healthcare that they’ve been in at least 15 years. In spite of the group’s higher exposure to China and to macro relative to Healthcare, alongside generally tougher comps in 2Q. vs. the S&P, the group in June matched a 12-year high relative multiple. When we flag valuation and our macro concerns to investors, we rarely hear any outright negativity and often hear a positive view of Tools as it is perceived as a safe haven. Our work continues to point to underappreciated exposure to global trade slowing (See: Multi-Industry: Macro Primer - It’s Choppy Out There) and to drug pricing pressure. We will release our full GTMI set for the quarter (See: Our New Tool: Introducing the GTMI) in coming days - we expect further signs of caution.
A window into the most critical investor debates. We detail investor feedback on our coverage rollout, summarizing themes from our 130 client meetings and calls since our launch. The debate is most intense around ALGN, ILMN, and Agilent, while TMO and DHR are considered most consensus and insulated from end market challenges.
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