IDXX - IDEXX Laboratories Q1 Earnings: Strong Results But Hard To Justify The Price

2023-05-06 06:15:27 ET

Summary

• IDEXX Laboratories' share price continues to consolidate after the massive rally since September last year.
• The latest earnings were very upbeat as the bottom line saw double-digit growth amid ongoing margin expansion.
• The company's valuation is still very hard to justify, as it continues to trade at a meaningful premium compared to peers.
• I rate the company as a hold.

Investment Thesis

IDEXX Laboratories (IDXX) is roughly flat since my last coverage in February, as the share price continues to consolidate after the huge run-up since June last year. Thanks to its resilient and expanding addressable market, the company's performance continues to be very strong. Despite facing a deteriorating macro backdrop, the latest earnings remain outstanding with double digits growth and margin expansion in the bottom line. While I really like the company's fundamentals, the valuation continues to be a major issue that could limit the upside. Therefore I reiterate my hold rating on the company and will wait for a more attractive price point before entering.

Upbeat Q1 Earnings

IDEXX Laboratories announced its first-quarter earnings earlier this week and the results are very solid, especially the bottom line which continues to benefit from margin expansion. The company reported revenue of $900.2 million, up 7.6% YoY (year over year) compared to $836.5 million. On a constant currency basis, revenue growth was 9.8%. Most of the growth was driven by the CAG (companion animal group) segment, which grew 8.7% YoY from $761.2 million to $827.3 million, accounting for 91.9% of total revenue. The growth of the segment was very broad-based, led by veterinary software which was up 13.2% from $59.4 million to $67.2 million. Rapid assay products also grew 10.1% from $74.5 million to $82 million.

The water segment was solid, with revenue up 6.9% YoY from $36.4 million to $38.9 million, accounting for 4.3% of total revenue. The segment benefited from both higher volume and pricing. LPD (livestock, poultry, and dairy) was the weakest segment, with revenue down 5.4% YoY from $30.9 million to $29.2 million, accounting for 3.2% of total revenue. The segment continues to be soft as demand from overseas remains low.

The bottom line was excellent as the company continues to improve its operational efficiency. Due to higher software margins and productivity initiatives, gross margin expanded 70 basis points from 59.6% to 60.3%. This resulted in the gross profit up 12% YoY from $498.8 million to $558.8 million. Operating expenses as a percentage of sales also declined 70 basis points from 29.9% to 29.2%, as spending remains disciplined. This resulted in the operating income up 13% YoY from $248.3 million to $280.4 million. The operating margin grew 140 basis points from 29.7% to 31.1%. The diluted adjusted EPS was $2.60 compared to $2.21, up 18% YoY.

Thanks to the upbeat momentum, the company also raised its lower-end guidance for FY23. The company now expects revenue growth to be 7.5% to 10%, up from 7% to 10% previously announced. Diluted adjusted EPS growth is expected to be 20% to 26%, up from 19% to 26%.

Strong Resilience

The economy has been weakening in the past few months and many companies are starting to see meaningful impacts on their business. However, I believe IDEXX Laboratories should continue to do well. As shown in the recent earnings, the company's growth remains very consistent despite facing increasing macro headwinds. Unlike other sectors, spending on companion animals' health-related services (eg. screening and diagnostics) remains very strong. As shown in the chart below, you can see that the US customer retention rates of IDEXX's products are over 97%, which indicates almost no churn at all. These services are extremely sticky as they are mostly recurring and non-discretionary. Pet owners are generally also reluctant to reduce their spending as they prioritize the health of their pets. The company's business nature provides great resiliency and I expect its growth to outpace others in the near term.

Elevated Valuation

While IDEXX Laboratories' fundamentals remain strong, it is still very hard to justify the company's lofty valuation. The company is currently trading at a PE ratio of 56.5x, which is pretty expensive compared to other diagnostic devices companies such as Zoetis ( ZTS ), Thermo Fisher ( TMO ), and Neogen ( NEOG ), as shown in the chart below. The peer group has an average PE ratio of 35x, which translate to a meaningful discount of 38.1%. The company is growing both the top and the bottom line at a faster pace, but the magnitude of the valuation gap still seems a bit too much. I believe the company is now likely fully valued and should offer limited upside in the near term.

Investors Takeaway

Overall, I believe investors should be patient with IDEXX Laboratories. The company's recent earnings were strong as revenue growth remains solid while the bottom line once again saw margins expanding. Its resilient fundamentals should also help drive durable double-digit EPS growth in the long run. However, the elevated valuation continues to be a notable concern that could limit the potential return. I believe a decent pullback is needed for a more compelling entry point therefore I rate the company as a hold for now.

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