In ‘17-‘19, China at ~10-20% of sales for Tools coverage accounted for 60-132bps of the 6.6% Tools organic CAGR. Slowing China since mid ‘19 (-1100bps of % growth on aggregate; Exhibit 5) prompted our analysis of federal revenue and spend trends to assess the long-cycle trends underlying the decel that was also flagged by our GTMIs last summer. We find that Govt spending in China health/science categories rarely decouples from spending aggregate growth, which has slowed, and appears at risk given a falloff in tax/tariff revenue growth as GDP slows and tariffs have an impact. Coronavirus likely confounds assessment of near-term trends, but the glide path is slowing on the back of macro, policy, and tariff concerns. We remain cautious on the group multiple on category deceleration; valuation details on page 7.
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MTD put up a big 4Q all things considered, but the multiple and decelerating profile are concerns. Amidst a mixed group of Tools earnings reports, MTD with its lower capital exposure and underappreciated mix shift away from true Industrial delivered stable organic growth considering it was another tough industrial/lab comp. What’s even more impressive is the margin trend - organically MTD is in an exceptional OMX cycle post the Tampa transition (Exhibit 7) with bps improvements running almost 2x the historical norm. MTD is however decelerating and holds a premium multiple, leaving a balance between quality and valuation; remain Peer Perform, PT to $704.
Investor focus is on coronavirus and on tougher comps for ’20; the bridge says that while these are valid points, consensus is achievable. We scrubbed the mechanics of our revenue bridge for XRAY to ’20 and beyond, evaluating both the mechanics (how to account for past inventory challenges) and the inputs (considering the sizing of the Primescan, Primemill, and SureSmile opportunities). We detail the bridge in Exhibits 3, 14, 15. Taking into account inventory dynamics and ex. NPIs, XRAY underlying sales growth is now tracking positively, though only modestly so. Over the next year, the ramp of Primemill should allow XRAY to continue to grow organically >3% ex-PM/FX, even if we assume no underlying improvement tied to One DS or new management’s efforts to drive commercial execution and launch ancillary products. All-in, XRAY largely remains positioned to drive its own results. We maintain our Peer Perform rating and lower our PT to $65 as our margin and earnings estimates come down on reinvesting cost savings.
We continue to anticipate >MSD growth top line in ’21-’22, driven by the fade of a series of headwinds and the scale-up of QIAStat, with upside optionality from dPCR (QIAcuity) and NeuMoDx (not in our model). Specifically, headwinds in ’20 include -$10-$15Mn (-80bps) in Comp. Dx in 1H, the NexTel Biotechnologies divestiture (-30bps), GeneReader termination (-40bps), HPV business expected to be down -70bps after a flat ’19, or a total of -220bps of headwinds that fade by 4Q20. We cut our sales estimates by -1% for ‘20/’21, but raise ‘20/’21 EPS 2-4% on reduced R&D expenses post-NGS divestiture and improved tax efficiencies. PT unchanged at $43 based on a FCF yield of 4.5%, which compares to our Tools average (ex-ILMN) at 3.2%, to embed risk cushion given ongoing transitions. Maintain Outperform.
Expectations were set for results at or slightly above guidance, and 4Q validated the new management team’s take on the outlook, including the impact of the GeneReader 2 termination and pressures in China tied to the unwind of QGEN’s JV. All-in, an inline result high-level. 4Q’s 390bps of margin expansion confirms that post the GeneReader 2 program termination, QGEN has room to grow targeted R&D and commercial while growing margins over 50bps sustainably. When we consider that China is costing QGEN ~-70bps and the GR2 termination (including the impact on CDX and hardware) is costing them ~-50bps, the guide for 3-4% for ‘20 implies underlying 4-5% growth, with upside as QIAStat ramps over time and if dPCR ramps. Given the path to acceleration and QGEN’s 4.5% FCF yield vs Tools at 3.8%, we remain comfortably Outperform rated.
Entering ’19, WAT guided for MSD growth after a solid 4Q; entering ’20, WAT is coming off a tougher – though stable overall - quarter. By some measures, the ’20 guide implies the toughest top line year for WAT since the ’09 cycle – if this proves accurate, it should prove a trough, as growth in China faces persistent but not structural pressures from 4+7/pharma, lab transition/Food, and industrial/applied slowing on macro weakness, in line with our thinking and the indications in our GTMI series in our 2020 Outlook. All-in, the top line outlook seems a bit conservative, though confirming tougher end markets near-term; aggregated Tools trends incl 4Q on page 3.
Waters management commentary in January called for a positive reversal and gave us caution regarding our structurally negative view, but the 4Q result and ’20 guide (full year LSD sales growth vs our 4%+) quickly return the tone of the message to a more somber state. Guidance for only a nominal top line acceleration in ’20 implies the toughest top line outlook since the ’09 cycle and an underlying deterioration vs ’19 considering the easy comps. WAT update provides a first direct view on whether the easy comps set by China Food and China 4+7 drug purchasing pressures in ’19 set the region up for recovery. As we flagged over the weekend, we believe there are emerging challenges in China unrelated to these headwinds and unrelated to coronavirus, but all three concerns are unknowns for Tools; at the same time, WAT’s 4Q result in TA raises questions about the company’s exposure to Industrial/Applied as a headwind for ’20.
NVST reported 4Q revenue of $721mn, below our $734mn and Cons. $729mn. The miss vs. our est. was driven by the SP&T segment, while E&C (the slower grower in general) was ahead of our forecast. The miss in SP&T reflects rationalization of value implants, which we estimate cost NVST ~$7mn in 4Q and is expected to persist into 1H20, as well as salesforce reorg. efforts. We estimate value implants also had a 50bps negative impact to EBIT margins in the quarter. Overall EBIT margins declined 90bps, but this largely reflected incremental public company costs. Excluding impact of public company costs and value implants, NVST showed ~60bps improving margin trends in 4Q. We have revised our revenue growth estimate lower by 40bps to reflect the impact of value implants in 2020 and by 120bps for growth trends in SP&T.
TMO’s ’20 outlook absorbs 25bps margin pressure from contract transitions and commercial org reinvestments, takes a conservative tact on the top line, and still bracketed EPS consensus, with the benefit of 50bps of tax rate decline and $1.5bn in buyback – operationally we call it in-line. For the stock, expectations were higher on the catalyst, however, as TMO carries the burden of expectations set by ’18-’19; the stock entering the day was +800bps above its 5-year average premium to Tools. As with Agilent, MTD, and DHR, investors now expect another year of beat/raise from TMO; the debate will remain polarized and we will remain data-dependent; the latest data continue to us to suggest that Tools companies under-indexed to pure life science/biologics are at a greater risk of slowing.
DHR’s close to ’19 was known from the preannounce, and management commentary set expectations for a solid ’19. The 4Q call was incremental on: 1) Expect GE/Cytiva accretion at $0.60, meaningfully above prior guidance (adjusted for a 3-quarters basis post a 4/1 close) on lower financing costs ($150mn vs prior $500mn); guidance continues to anticipate 6-7% growth; DHR sees upside potential. 2) Core ’20 outlook faster (MSD+) for Diagnostics and Life Sciences (ex GE). 3) China remains HSD into ’20, stronger than peer trends in terms of accel/decel into ’20, in part with CPHD support. 4) Sciex expected to remain 3-4%; headwinds from China Applied persist; manageable for DHR but potentially persistent drags for Agilent/Waters; their easy comps leave us still anticipating acceleration. 5) Pharma growth should “normalize” in ’20 but not due to bioprocess overcapacity, more the supernormal trend of recent years, also directionally in-line with TMO thinking. All-in – for DHR, the 5% core guide looks to embed almost a point of cushion (as does TMO’s 5%), 4Q was robust in spite of more signs of industrial/applied moderation, but we do hear caution on pharma that demands further diligence.
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