AVTR - Waters Corporation: Stable But It Doesn't Offer Much Upside

Summary

• Waters Corporation has been a source of relative stability over the past several months, with the company performing slightly better than the broader market.
• This comes as sales rise but also while profits and cash flows come under some pressure.
• If shares were cheaper, the company would be a decent prospect, but the stock is a bit lofty to offer material upside.

The ideal scenario for any investment is that the investor making the purchase would see some attractive upside. Having said that, there are times when even experiencing stability could be considered a win, such as when the market experiences downward pressure. One company that has experienced this stability that I would not have previously imagined would is Waters Corporation ( WAT ), a firm that's dedicated to providing a variety of goods and services such as liquid chromatography technologies to its customers for the purpose of identifying and analyzing constituent components of chemicals and other materials. The company also provides thermal analysis and other related instruments to its customers. In recent months, the market has taken a slight step lower. Even so, Waters Corporation has held up relatively well. This seems to be an ongoing trend for the company. For investors who crave stability, this might be the kind of opportunity to consider. Though given how pricey shares are on an absolute basis, I can't yet give it a 'buy' rating.

Stability in the face of profit pressures

Back in the middle of August 2022, I wrote an article wherein I revisited my investment thesis regarding Waters Corporation. In that article, I talked about how the company continued to grow its top line. However, I was turned off some by the weakness experienced on its bottom line. Despite that pain, I felt as though the picture as a whole was looking up and that the long-term outlook for investors would probably be positive. But because of how pricey shares were, I could not bring myself to pull the trigger. Instead, I ended up rating the company a 'hold' to reflect my view at the time that shares should generate upside or downside more or less in line with what the broader market should achieve. Since then, the company has done well compared to the broader market. While the S&P 500 is down 4.6%, shares of Waters Corporation have seen downside of only 2.2%. This seems to be an ongoing trend. Because of the quality of the company, whenever the market drops, Waters Corporation seems to drop a little less. For instance, from the time I first wrote about the company back in January 2022, shares are down 11.7%. Although very painful, this is better than the 14.7% experienced by the S&P 500.

One thing that might be helping to prop up the company's shares is the fact that management continues to deliver when it comes to revenue growth. Consider the third quarter of its 2022 fiscal year. During this time, sales came in at $708.6 million. That's 7.5% higher than the $659.2 million generated one year earlier. Service sales for the company rose only about 1% during this time. By comparison, product sales shot up 11%. According to management, the sales growth for the company was driven by strong customer demand across most of the major geographies in which it operates. Most end markets and product categories also experienced sales increases. Interestingly, growth would have been greater had it not been for foreign currency translation. That impacted sales growth by the tune of 8% during the most recent quarter.

Although it's great to see revenue increase, profitability for the company took a step back. Net income dipped from $161.2 million to $156 million. Even though the company benefited from an increase in the volume of products sold and a rise in prices that it sold the products at, these were more than offset by higher electronic component and freight inflationary costs. The aforementioned foreign currency fluctuations also hit the company's bottom line by an unspecified amount. Unfortunately, other profitability metrics followed a similar trajectory. Operating cash flow dropped from $167.9 million to $158.1 million. If we adjust for changes in working capital, it would have fallen from $203.8 million to $192.2 million. Meanwhile, EBITDA slept only modestly, falling from $224.8 million to $224.5 million.

When it comes to the first nine months of 2022 as a whole, the company still saw revenue increase, rising from $1.95 billion to $2.11 billion. During this timeframe, profits actually improved, rising from $476.6 million to $480.7 million. Other profitability metrics were rather mixed. For instance, operating cash flow fell from $529.3 million to $413 million, while the adjusted figure for this declined from $605.7 million to $599.9 million. Meanwhile, EBITDA for the company actually managed to increase during this time, rising from $657.3 million to $696.7 million.

For 2022 in its entirety, management said that , on a constant currency basis, sales should grow by between 11.5% and 12%. However, they also said that foreign currency fluctuations will impact sales by roughly 6%. Using midpoint figures here, that implies a GAAP revenue growth for the year of 5.75%. Earnings per share, meanwhile, should come in at between $11.85 and $11.95 on an adjusted basis, with an 11% hit from foreign currency translation included in this figure. Using the midpoint here, that would imply net income of $715 million. If we assume that other profitability metrics will rise at the same rate that net income is forecasted to, then adjusted operating cash flow should be $889 million, while EBITDA should come in at $1.02 billion.

Based on these figures, the company is trading at a price-to-earnings multiple of 27.3. The price to adjusted operating cash flow multiple is 22, while the EV to EBITDA multiple should come in at 20.2. By comparison, if we were to use the data from the 2021 fiscal year, these multiples would be 28.2, 22.7, and 20.9, respectively. As part of my analysis, I also compared the company to five similar businesses. On a price-to-earnings basis, these companies ranged from a low of 4.1 to a high of 41. In this scenario, two of the five companies were cheaper than Waters Corporation. Using the price to operating cash flow approach, the range was from 16.9 to 53.3. In this scenario, three of the five were cheaper than our target. And finally, using the EV to EBITDA approach, the range was from 3 to 21.8. In this case, four of the five firms were cheaper than our prospect.

Takeaway

Fundamentally speaking, Waters Corporation is doing okay. In fact, the company is doing better than its numbers let on. The foreign currency impact is definitely harming the company in the near term. However, I believe that the market understands this and that adds to the stability the company is experiencing. In short, the market sees a business that continues to grow its top line, that is having at least a fairly stable bottom line with only transitory issues affecting those results, and rewarding shareholders accordingly by ensuring that the company's stock does not sink more than what the broader market does. For investors who value stability above all else, I couldn't understand why Waters Corporation would be an appealing prospect. But because I seek capital appreciation in excess of the broader market, I have no good answer other than to rate the business a 'hold' because of how its shares are priced.

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