Thermo Fisher Scientific (NYSE: TMO) is a healthcare sector juggernaut that produces and supplies scientific instruments, reagents, consumables and offers contract services through its CDM and CRO businesses. With a galaxy of critical services and products, Thermo Fisher is a force to be reckoned with in healthcare.
Two key competitive moats
One key strategic advantage that Thermo Fisher has is its strong distribution network which allows it to efficiently distribute its products. This is essential as hospitals, diagnostic clinics, and research institutions want to receive their ordered reagents in the shortest time possible. This eCommerce-like service standard of delivering goods within their promised timeline has built massive credibility for the company.
In addition, Thermo Fisher has a large army of researchers who are consistently developing new solutions to continuously support innovation in the healthcare sector. This allows the company to stay at the forefront and occupy the top spot in the minds of scientists, lab technicians, hospitals, and diagnostics labs. These various factors have allowed Thermo Fisher to grow and expand its business which now commands a market capitalization of US$250B.
A look at Thermo Fisher's growth
For full-year 2021, Thermo Fisher reported $39.2 billion in revenue, 58% derived from repeatable sales of consumables and 22% from maintenance and other services. Looking at the sector break up, Pharm & Biotech made up 42% while Diagnostics & healthcare made up 30% of revenue. Often these two groups find it difficult to fid substitute products for Thermo Fisher’s offerings. The company ensures a fuss-free service quality by placing dedicated sales representatives at the clients' locations to ensure a seamless ordering experience. These benefits have resulted in extremely reliable performance quarter after quarter.
Looking ahead, management expects revenue growth to come in between 7% and 9% every year, while this is slightly slower than the 13% compounded annual growth rate (CAGR) which was reported by Thermo between 2011 & 2021, it is still a healthy pace of growth. One potential headwind in the near term will be the reduction in COVID-related sales which came in at $7.7 billion. However, Thermo Fisher has prudently invested its COVID windfall to expand its operations by virtue of its US$24B investment in M&A activities during the past year.
Moving to look at the company’s balance sheet and cash flow position. Thermo Fisher had US$4.47B in Cash & equivalents and US$34.87B in debt. While the net debt position is on the high side, the company generates very strong free cash flows (FCF) which should allow it to easily meet its debt obligations.
On the cash flow front, Thermo Fisher generated US$6.8B in free cash flow (FCF) and has grown FCF at a 17% CAGR over the last ten year. FCF should continue to see continued strength as Thermo Fisher prudently expands its operations both organically and inorganically. Management has also been shareholder-friendly as it uses its strengthening FCF position to finance dividend hikes and share repurchases. This will be beneficial for both new and old shareholders alike.
Some potential risks
The biggest risk factor for Thermo Fisher is the economy going into recession. As Thermo Fisher is reliant on a robust and growing R&D market for its consumable sales, in a recession R&D is usually the first to experience budget cuts. This would likely mean lower revenue for most of its various business segments.
The other risk is competition. While Thermo Fisher is a leader at the moment, other healthcare tool companies are eyeing this position. Some potential competitors would be Danaher Corporation (NYSE: DHR), Roche (ROG.SW), Bio-rad (NYSE: BIO), and Bio-Techne (NASDAQ: TECH).
A brief word on valuation
Lastly, looking at valuations, Thermo Fisher is currently trading at 31 times FCF. We feel this is slightly pricey, and a price/FCF ratio between 25-28 would be a fair multiple to pay based on historical trends. We would be interested buyers in that range if the economy holds up, however if we see increasing risks of a recession we would be buyers closer to the 20-22 price/FCF ratio.
Wrapping it up
To wrap it up, Thermo Fisher is a healthcare juggernaut, that has been consistently growing its top line at a faster pace compared to overall industry growth. On top of that, the company has shown the ability to grow its FCF at a fast clip. These factors together with the fact that Thermo Fisher has a strong product & services portfolio and a wide distribution network, indicate to us the strong competitive moat the company has compared to its customers. With that, we leave it up to you to decide if you want to participate in the company’s growth.
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Disclaimer: All opinions shared in this article are the opinions of the authors and do not constitute financial advice or recommendations to buy or sell. Please consult a financial advisor before you make any financial decisions.