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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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.
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.
Tools stocks outperformed the S&P 500 by 970bps in 2019 for a 38.6% weighted return, 1,000bps ahead of the S&P in spite of entering the year at an historically elevated premium (Exhibit 3), and are beating the S&P by 200bps in ’20 YTD (Exhibits 5 and 6). On relative EV/EBITDA, multiple premia are now down from their ’19 peaks by 1500 bps, but still 1500bps above the ’15-’17 norms. In this report we aim to assess both Tools and Dental stocks with a cash-centric and market-relative approach, and update our FCF-based price targets to reflect the higher market multiples for the sector. We raise our PT’s on Tools stocks by 10.1% on average to mark to market (Exhibit 2). Our group target average yield assumes a reversion to the ’15-’18 norm, or 15% above current, which implies EBITDA multiples 2.5 turns lower than current, as our end market analysis continues to imply a category organic growth deceleration, as outlined in our 2020 Outlook report.
Given Qiagen’s announcement on 12/24 that the company and Board have terminated discussions with potential acquirors, we revert to our standard valuation method and prior year-end ’20 PT of $37. Our upgrade to Outperform on 10/17 was valuation-driven with the stock at $27.54 and our PT raise to $50 reflected an expectation of a deal given QGEN indications that they were engaged with multiple suitors; neither the deal nor valuation now gives support for the stock. Shares indicated pre-market at $30 may be near-term oversold on M&A-related investor rotation.
The joint results of our Pharma and Academic surveys imply that in 46% of the overall Tools exposure matrix, growth is stable if not accelerating. This is both an encouraging and confounding result. On one hand, the bullish narrative that biomedical innovation supports broader growth for Tools clearly has legs. On the other hand, the multiples demand resilient growth, and a hiccup in funding/spending trends could bring a healthy reset to the multiples by taking out some portion of that expectation. For the time being, we remain long-term bullish with concerns around the under-appreciation of the link between cyclicality and growth in much of the category exposure matrix.
Survey says pharma trends ~steady in base R&D, a bit of a relief. Given the macro backdrop and choppiness in parts of pharma, the call for R&D acceleration in our November survey (29 labs, multinational biopharma) is a positive surprise and encouraging for Tools broadly. Overall budgets are expected to accelerate ~130bps in ’20, similar to ’19, and suggest a solid 4Q budget flush. This result does no address concerns in generics/QAQC or capture biotech funding trends, but does alleviate concerns on any large pharma R&D pause tied to a potential drug pricing policy change in the US next year. With 39% of Pharma demand in R&D (Exhibit 32) representing ~10% of overall Tools revenue, our survey results are a significant relief for Tools in ’20.
After scrubbing our models and valuation engine, we find little cause to make meaningful changes to positioning for the group. Our caution was warranted into 2Q results as growth slowed, but confounded on 3Q results as fading industrial/applied trends were offset by strong biopharma demand trends across products and services, and bellwether large caps either posted strong (TMO, DHR) or improving (Agilent) growth trends with support from Diagnostic trends that are less relevant for the overall category. Risk-reward remains attractive on QGEN as we anticipate a deal close, and TMO/DHR offer both high visibility and robust core growth, as was the case into 3Q. Agilent and PKI are closer to being attractive stocks; we would be more positive on both on a cyclical upswing. We modestly raise our organic growth outlooks for TMO, DHR, and MTD; and lower for BRKR, Agilent, and PKI.
We introduce a quarterly look at Tools/Pharma indicators and new CRO demand indicators in 38 Exhibits. Key observations: 1) While most indicators are steady, we see no upward inflicting indicators, and there is a slowing bias in monthly Tools/Pharma data series outside of Bioprocess. 2) Funding (IPO/VC) indicators are moderating, a bearish early signal for biotech. 3) Generic deflation (both US and international) looks stable, a persistent headwind (traction for Valletta and BeneluxA suggest ex-US trends may worsen). 4) Ex-US spending trends (Europe, India) appear to be recovering. 5) FDA approvals are stable, but no longer growing, yr/yr.
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