PKI, MTD, BRKR were laggards last week (-4%/-2%/-2% respectively), moves that mirrored our net exposures matrix (updated in Exhibit 3) with concerns on EM/hardware. At the group level, it was a net-zero week vs the S&P with Tools’ P-E premium to the S&P static at 35%; group EV/EBITDA premium at 62% (Exhibit 25). Since 1/23, Tools as a group is down -18% cap-weighted vs the S&P -25%, and Med. Devices -20%.
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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%.
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%.
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.
ILMN in 1Q will face an accelerated headwind from the NextSeq launch, a pop seq drag, and most acutely a decline in arrays from the DTC franchise decline. Bears point to weak growth headlines, but ILMN has made it clear NGS consumables growth should remain on trend, and our structural bull thesis is acutely tied to the data generation curve. Expect the stock to remain a challenge tactically on the optics. While it is a source of frustration, ILMN management is watching other indicators, as they observe the availability of NGS capacity and its efficiency unlocking methods that will drive accelerated NGS capacity demand in coming years by driving clinical and translational efforts. NGS data generation is up ~50% for ‘18 and ‘19, confirming NovaSeq is driving elasticity and building a vast moat. While AGBT diligence was muted on NGS spend growth, the growth lies elsewhere, as the data acceleration (Exhibit 6) confirms.
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.
The ILMN 4Q was another CAGR deceleration for the NGS business, considering the easy comp. IVD (diagnostic kits/collaborations) sales drove a 4Q sales beat, but are unlikely to drive growth in ’20 ahead of the TSO500 approval which should help ’21. The growth outlook for ’20 was already known; the growth bridge for ’21 is more attractive, with HiSeq’s decline a smaller issue and arrays likely stable after another year as a 200+bps drag, but the near term optics likely remain tough, even with the UK BioBank running full-bore and pop seq programs turning on in coming months. We remain long-term bullish on pop seq but the Nova transition, driving down HiSeq revenues is still the dominant consideration for the top line, and arrays further pressure the optics. Owning ILMN is about the acceleration from here – we model EPS growth to 20%+ post ’20, and pop gen programs and product cycles become tailwinds by year-end. PT goes to $371 from $412 on microarray pressure.
We reviewed earnings transcripts for companies in our coverage through the 2003 SARS and 2009 H1N1 outbreaks. Impacts cited related to these outbreaks were typically modest (up to 3% sales impact in a peak quarter), and we saw a mix of positives (demand for diagnostics, vaccines) and negatives (dental visit disruption, macro pressures). While the average exposure in our coverage to China is in the high-single digits, we expect the impact to our companies of the coronavirus outbreak to be limited unless the outbreak gets significantly worse. Increased sales of diagnostics products and medical supplies are likely to offset by sales challenges in China due to travel restrictions and other business challenges.
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