WAT - Waters Corporation Q1 Earnings: If It Rains Go To Waters

2023-05-12 09:39:37 ET

Summary

• Waters Corporation has seen shares correct some 15% in the time span of a few months.
• This came after a soft first quarter earnings report, as the company maintains the full year guidance.
• Valuations have re-rated to a lot more attractive levels here.
• While the appeal is starting to lure me, I am waiting for another small leg lower before getting involved with Waters Corporation.

Early in March, I called Waters Corporation (WAT) a great growth gem, although a bit pricey. The company has delivered year-in, year-out on steady growth, on the back of the positioning (and hence organic growth), bolt-on dealmaking and share buybacks, as investors have subsequently awarded the shares a premium valuation. It just reported Q1 2023 results .

An earnings multiple in the high-twenties made me cautious given the interest rate environment in which we found ourselves, as the company, moreover, announced a substantial deal which was set to jack up leverage ratios a bit.

A Recap

Waters focuses on liquid chromatography, mass spectrometry and thermal analysis innovation. Basically, Waters makes sure that medicines and vaccines obtain efficacy, safety and quality which are desired. These products and solutions allow for purity of both food and water, increasing the durability of products and services.

The company generates about $3 billion in sales, some 60% from the pharmaceutical industry, 30% from industrial and applied applications, and the remainder from academic and government clients. Revenues are largely equal between (upfront) equipment sales and services and materials.

Over the past decade the company has essentially grown revenues from $2 billion to $3 billion, on average growing at a decent 4-5% per year. With operating margins stable in the mid-twenties, and amidst a 30% reduction in the share count, the company has seen solid growth on a per-share basis. This growth drove a rally from $100 in the shares in 2013 to $200 in 2018, with shares even peaking above $400 per share in 2021. Ever since shares have traded in a $250-$350 range, trading at $320 in February.

For the year 2022, sales rose 7% to $2.97 billion as net earnings rose in a very modest fashion to $708 million, with earnings reported at $11.80 per share. The limited increase in earnings was due to higher tax rates and interest rates, as the company ended with a net debt load of $1.1 billion. The company outlined a solid 2023 guidance with organic sales seen up 5.0-6.5%, with adjusted earnings set to rise modestly to $12.65 per share.

A 60 million shares count at $320 valued equity at $19.2 billion, and including net debt the valuation came in at $20.3 billion, equal to 7 times sales and 27 times earnings.

The company announced a $1.36 billion deal for light scattering instruments and software company Wyatt Technology in February, adding bioanalytical characterization activities, including cell and gene therapies. A $110 million revenue contribution reveals that the deal is not cheap, although that growth rates surpass that of Waters, while margins are apparently very strong.

Net debt will jump to $2.5 billion overnight, as I see no-near term earnings contribution, given the associated and incremental interest expenses, although it might drive accretion over time and bolster the growth profile of the business.

Trading at 27 times earnings, the valuation was far too high, as I was looking to initiate a position at 20 times earnings, recognizing the quality of the business, translating into a $250 per share desired entry point.

That Came Quickly

Since February, Waters Corporation shares have fallen from $320 to $269 per share, with shares down 15% in the time span of merely three months here. After shares fell to the $300 mark in the ordinary course of trading in recent weeks, shares fell essentially overnight to $270 upon the release of the first quarter results which looked a bit soft.

Turning to the recent earnings release, first quarter sales fell a percent to $685 million, with constant currency growth reported up 3%. Following some higher expenses across the board, the company saw operating margins fall from $195 million to $174 million, with higher interest expense causing net earnings to fall to $140 million. Amidst a small reduction in the share count, earnings per share were down just twenty-four cents to $2.38 per share, with adjusted earnings seen eleven cents higher.

Despite the softer quarter, the company still sees earnings this year at $12.65 per share, including a $0.15 per share headwind from Wyatt. Acquisitions, or betters said Wyatt, are set to add 2.5% to sales this year, which worked down to about $75 million in dollar terms. With the deal set to close in mid-May, the annual revenue contribution is pegged at around $120 million. Ahead of the deal, the company has managed to reduce net debt to levels just below the billion dollar mark.

And Now?

The reality is that Waters Corporation started the year off a bit soft, and while maintaining the full year guidance likely implies a small risk to this guidance, I am still quite upbeat, mostly as the valuations have been reset quite a bit here. A 27 times forward multiple has dropped to about 21 times here, as the earnings yield rose a full point with the long-term positioning being still good.

This makes me quite upbeat here about Waters Corporation. While I am getting tempted to buy the dip already, I am reiterating my 20 times desired multiple, as I look for a further dip to the $250s before getting involved with Waters Corporation here.

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