We compiled revenues and expenditures for 220 biopharma companies with a total of $127bn in sales, isolating biotech and biosimilar revenues, to evaluate relationships between biotech company trends and Tools bioprocess-related sales, as well as the near- and long-term bioprocess outlook. Bioprocess drives 5% of sales for TMO and 20% for DHR including GE proforma, but is less material for others in the group. Our analysis confirms recent bioprocess acceleration for Tools has support from underlying biotech acceleration, and suggests bioprocess should accelerate further medium term, even if macro headwinds accelerate, driving 50bps of growth for TMO (pharma services including trial services and CDMO are incremental drivers that benefit from acceleration in biotech) and 200bps for DHR; we remain Outperform rated on both. Details in 11 exhibits inside.
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QGEN is launching 4+ new systems in ‘18-‘20, introducing a complex array of moving parts – Incremental growth, incremental spending, sales force transition, and uncertainty around new system traction. The long term for QGEN looks intriguing, but gaining comfort with the model is uniquely challenging. We attended a lunch with CFO Roland Sackers and IR John Gilardi; incremental granularity added bits of clarity, and EPS should accelerate in ‘20 on fading divestiture/exit headwinds and R&D acceleration, but the catalyst path remains hard to map; we are Peer Perform rated, PT $10/31% upside to year-end ‘20.
Entering a phase of slower Pharma demand. Global drug acquisition policy is impacting planning by drug companies WW. While US generics trends are known to be persistently tough on price (Exhibit 13) and China’s 4+7 program is now better understood (Exhibits 22 and 23), a slower lineup of new Gx opportunities are ahead (Exhibit 6) in the near term and international buying groups are driving accelerated deflation in recent months (Exhibit 10). None of these issues is catastrophic, but deflation trends are worth watching and a weak FDA approval trend (Exhibit 17) and limited new generic opportunities introduce the risk that Pharma demand for Tools looks likely to slow in ’20. We continue to expect organic growth deceleration and multiple compression vs the S&P, as flagged in our 2H Tools Outlook; we forecast 200-400bps deceleration in ’20 vs ‘18. DHR and TMO have better offsets with bioprocess, Agilent has an NASD counterbalance that drove 25bps of growth in their July quarter, Waters and Perkin are more net-exposed without bioprocess; detailed matrices in Exhibits 1 and 26.
Slower growth and lower leverage leave risk, albeit smaller than into 2Q, to the multiple – Tools sector organic growth in 2Q slowed by 70bps relative to 2H18, and the S&P-relative P/E multiple is down to a ~40% premium (see sidebar) or 2000bps lower vs July 1st. The historical norm closer to 30% remains a likely destination as group organic growth returns to the 3-5% range that many companies assume is the norm through the cycle vs ‘18’s 7%+. We lower our PTs by 1-2% in anticipation of this shift as we expect more persistent slower growth. The counter-case to our view is that EV/EBITDA multiples are already back to historic norms relative to the S&P (Exhibit 68); the group could lever from the current 1.7x EBITDA back to the historic norm ~2.2x to close the valuation gap on P/E. We expect P/E multiple compression followed by a recovery of capital deployment as target multiples come in.
We provide high-level takeaways from a series of diligence meetings on China demand and policy trends. Our sources uniformly call for slowing China end markets, anti-American sentiment, China IVD/Device locals making inroads in Asia/European markets, and more coordinated government backed purchasing efforts that stand to drive price/mix lower in drugs, devices, and diagnostics regardless of competitive dynamics. As we flagged in our 2Q Retrospective, China growth has slowed from 17.9% to 11.5% in the last three quarters. Our GTMI runs from this week confirm deceleration continues. If there is a silver lining amidst calls for slowing, it’s that BGI quality problems (NGS and NIPT) persist and leave US players well positioned competitively.
Aggregate organic growth for our coverage slowed in 2Q by 100bps, or 70bps on a compound basis. As flagged by our GTMIs, Pharma/Diagnostics held up well as Bioprocess accelerated, while Government/Academic/Industrial pulled back (details in Exhibits 7-12). China slowed again, now by >500bps in 2 quarters. We continue to expect further slowing, from the 6-7% peak in 2H18 to 3-5% in ’20 (Exhibit 3); notably this growth rate for the markets is in-line with management planning assumptions and likely makes consensus achievable, multiples vs the S&P and healthcare (Exhibits 30-33 and sidebar) remain within the ’19 range which assumes faster growth.
Our view remains that while there are many moving parts in the model, the net change to the outlook was a very modest negative. We remain of the view that the lift to 4Q is attainable, but at risk. Perhaps more critically, the medium-term outlook remains contingent on success of systems still in R&D or early launch, including dPCR, NeuMoDx, and QiaStatDx. As we flagged previously, the back half has the benefit of a 100bps tailwind from the lapping of the Vet and 3rd Party service divestitures, QIAStat, QIACube, and QuantiFeron. Visibility on each is limited, but the big Instrument quarter is encouraging for Stat and Cube, and tuberculin shortages are a meaningful tailwind. Offsetting are a sharper HPV decline, the China JV, European market weakness on political shifts, and companion diagnostics.
The QGEN result at +5% CER/$0.33 missed our estimate and consensus by ~100bps top line, which was known last week on the preannouncement. The slow development of the China JV accounted for the miss; the balance of the business was ~in-line. Similarly, the full year guidance reduction by 200bps top line and $0.03 at EPS is essentially all China JV-related.
QGEN this evening (7/24/19) lowered guidance by 2% on the top line and bottom lines. The change relates to the termination of a China JV, as CFDA regulatory processes proved onerous. Expect QGEN to return to the market in ’20. QGEN’s top-line revision to ’20 revenue growth stems from a $30Mn CER China NGS outlook reduction on the JV restructuring; costing $27mn in 2H sales in Comp Dx. This change impacts EPS $0.02, again reflected in the guidance, and 2019 organic revenue outlook falls 200bp.
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