TMO and MTD were laggards last week, pulling the relative PE closer to historic norms. Given the 200bps of outperformance, the group’s EV/EBITDA premium to the market remains inflated at 57% (Exhibit 25). Since 1/23, Tools as a group is down -18% cap-weighted (wide, but narrowing variation in the group, see Exhibit 7) vs the S&P -24% and Devices -20%.
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The lack of high frequency data in Tools makes assessing trends amidst the current crisis challenging relative to many other industries. To attempt to bookend the possibilities, we reconstructed our customer-level GTMI series to take a look back to 1995 – through multiple recessionary cycles – to inform views on potential impacts of recession on Tools estimates. Our series reflect hard data including pharma production volumes, medical equipment production, and testing instrument production that have passed GTMI statistical filters. Our findings are presented on pages 2 and 3. In coming weeks, we will launch a set of new higher frequency tools as we attempt to compare the current cycle to prior cycles for modeling purposes.
We refresh our data-driven look at Tools positioning in the current environment, looking at fundamentals and recent moves, following on our China Updates. Tools as a category has multiples (even on stale consensus) near 1H19 peaks vs the S&P, up 1,500 bps in 2 weeks on EV/EBITDA, to 61% from 45%, (Exhibit 5). Since 1/23, Tools as a group is -22% cap-weighted (wide variation in the group, see below) vs the S&P -28% and Devices -25%.
As we have highlighted, Biopharma proceeds of $20bn is the single most important de-levering event for GE and a critical driver towards the YE20 industrial leverage target of 2. 5x. We have long viewed deal closure as a formality, given Danaher’s proactive funding for the deal and a clear path to regulatory approval. But the market has been questioning each and every deal under way, in light of the looming recession; especially ones that are critical to lower B/S leverage. As such, this news has to be viewed as a significant positive.
While COVID-19 test provision is a key priority for TMO, there is agreement that the broader environment is under pressure, with 2Q20 more uncertain than 1Q20. As flagged in our Agilent work, this looks less bad than the ’09 cycle and TMO is better positioned. 2Q20 could see TMO ship >5.0mn COVID-19 tests/week for some time, driving $200mn+ revenue on top of accelerated demand in the HC channel and Dx franchises, but bullish views miss the broader picture.
FY20 visibility is still low, but as we flagged last week and last night we have an early sense for relative exposures and some granularity on China impacts thus far. Agilent is unique relative to Tools peers in that the company has far higher exposure to oil prices but also very easy China comps, given FY19 disruptions in Food/Pharma. Our revised estimates assume that the broader environment in ’20 is recessionary, but not as deep as ’09. In FY09, Agilent sales were down MSD (Pharma -8%, Enviro/Forensic -15%, Food up, A&G flat) and EPS compressed by 13%. If Agilent’s comps and business mix in FY20 were identical to FY09, we could imagine revenues down LSD, but 400bps of mix shift to services, the scale-up of NASD, and easy China Food/Pharma comps are in total worth ~300bps to growth. Our revised 1-2% organic growth forecast and flattish EPS outlook are an effort to take these into account. For FY21, we now forecast organic +8%, slower than FY10’s +13%, considering tougher comps (800bps) but also a 150bps mix tailwind.
As we catch up with Tools co’s into quarter-end, companies are generally reluctant to be specific on 1Q, but themes are emerging. High level, we sense there is general agreement with our view that 1Q results likely land over 300bps below plan at the top line in many cases (smaller for companies with COVID in guidance; recall ALGN reiterated 1Q last week), with a wide degree of variation. Specific commentary on 2Q is nil. Companies with higher instrumentation exposures are most uncertain (see Exhibit 1 as well as Slide 4 in our COVID slides linked above). At the same time, the phrase “China is coming back” has been spoken more than once in our discussions, and there is a confidence that WW activity levels will recover over the course of 2H; both reassuring on one hand and concerning on the other as this implies expense controls will be limited and decremental margins therefore elevated. Interestingly, the fluidity of the COVID situation mutes the appropriateness of preannouncements, which could prove wrong on 2 weeks of progression. All-in, it feels like 2Q will be tougher than 1Q, even with 1Q below guidance for companies that guided with COVID in the numbers, as EU/US impacts are emergent and China disruption was more persistent than guided.
Aside from Agilent, where expectations were set for the April quarter to see ~-9% pressure on APAC sales from COVID-19 (Agilent is the only co in the group with a Jan-April quarter), there is limited commentary on the impact anticipated for Tools co’s. In Dental, XRAY guided for ~-70% pressure on APAC. This report aims to synthesize updates from a range of other healthcare/testing co’s, to approach a base expectation for 1Q; our discussions with Tools co’s find a view that sales likely see 2-5% pressure relative to expects, and for equipment-heavy players, these numbers would be larger.
In the near-term, exposures to the following are concerning for non-therapeutic Healthco’s: discretionary healthcare (exposed to hospital resource reallocation), applied/industrial (see: cyclical end markets) APAC, and instruments. We attempt, with admittedly limited visibility and an appreciation that we are perhaps nearer to the beginning than the ending of a challenging period, to quantify exposures on these metrics and consider which companies’ consensus figures have adjusted to contemplate these exposures. Our effort is admittedly tactical in nature, and the extent to which structural changes emerge from the current COVID-19 challenges persist is an unknown.
Bioprocess category growth, now that we have final data from the full group, came in at 12.4% (slowing by 300 bps, mostly due to a weak qtr from GE LS) after the big 3Q, though on a much easier comp (by 400 bps). That said, bioprocess grew 13.5% for the year, accelerating by 300bps vs. ’18. TMO, SRT, and Merck KgaA led the way, with growth 300-500bps above the 12.4% 4Q weighted growth rate (Exhibit 17). We detail companies most exposed in Exhibits 3 and 12, most critical for TMO and DHR in our coverage.
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