Business Breakdowns
· Matt Reustle, Mark de Vos
[00:00:00] S0: There's a history of it. It's not core to the thesis from year to year, but it can be a nice tack on when executed well. When thinking about valuation for Agilent or this type of business in general, how would you say investors generally frame valuation for this type of business? Whether there's a specific methodology—and feel free to group yourself in there with any type of methodology that you think is relevant? [00:00:00] S1: We tend to focus on either free cash flow yields or price to earnings multiples. I think we find them the right mix between simple enough to ensure usability but also comprehensive enough to actually be useful. Agilent, for example, is trading above 4% free cash flow yield in recent months, which is close to the highs it's been over the last 10 years. Basically since the Keysight spin, which we view as pretty reasonable for a business that we think should be growing earnings high single digit. That equates to a just sub-20 times price to earnings multiple. Again, looked reasonable for a business Agilent where cash conversion is pretty stable. The two are largely interchangeable generally. Try not to overcomplicate it. If we really we the business and we're confident about the long-term growth, then as long as the valuation looks reasonable we're likely to invest.
· Matt Reustle
[00:00:00] S0: I admire it. I will not poke any holes in it. Oftentimes I love a simple P/E multiple inverted into a cash flow yield when the earnings conversion is fairly smooth into free cash flow. So bonus points for me on that. Simplicity is often a good thing. You outlined it fairly simply. Even in that response where there's visibility into high single digit earnings growth, you do have this cash flow conversion. Would you say there's any tailwinds that could result in more material outperformance? I rarely have to mention this into an episode because usually we get a very bullish presentation of the different things. I think this has been very balanced and fair in terms of presenting the business and the outlook. Is there anything that you think is missing or not mentioned as a potential upside lever or catalyst?
· Mark de Vos, Matt Reustle
[00:00:00] S1: I wouldn't underestimate the need for telling what is in a sample and the unusual use cases that pop up for that. The most recent example of that I'd point to is PFAS testing or forever chemicals as they're often referred to in the press. There's a huge amount of regulation that's appeared in the last two, three years around testing food and the environment and chemicals as well for the presence of these PFAS. They're long-lasting chemicals that's used in everything from sort of nonstick pans to firefighting chemicals. The problem is they find their way into food and water and humans and children as well. And they've been shown to be harmful to consumers in several studies. There's a lot of regulation coming in. This is already a $400 million market growing 20% per year and Agilent is the clear leader in this market. So this is a sort of market that popped up overnight where we need to test this sample. Agilent's the clear leader in applied market testing and it's growing like a weed. So there's definitely upside from these testing markets seeming to appear out of thin air. [00:00:00] S0: Interesting example that paints the picture quite well. On the opposite side when you think about the risks, you referenced some of the cycle exposure that they might have. Is there anything else? Any customer concentration risk or anything else, whether it be from overseas, cheaper products, things along those lines that stand out to you?
· Matt Reustle, Mark de Vos
[00:00:00] S0: Interesting example that paints the picture quite well. On the opposite side when you think about the risks, you referenced some of the cycle exposure that they might have. Is there anything else? Any customer concentration risk or anything else, whether it be from overseas, cheaper products, things along those lines that stand out to you? [00:00:00] S1: The primary risk to the business we spoke about earlier is that cyclicality based on those big end markets. So if pharma isn't spending, that's not a great environment for them. They're not too reliant on US government funding or anything that. So academia and government is only just under 10% of sales. And actually the NIH related funding, which is the one that's particularly under pressure, that's only about 1% of their sales. So it's not a huge part. China's the only other part that's hard to forecast. I think we can be confident about the need for testing there in the long term. In the short term, of course it can be hard to predict. They're the main ones I'd point to. [00:00:00] S0: This question will come a bit out of order, but the M&A thesis that I described within the business, I'm curious if this is ever a target of M&A in terms of them being acquired, Agilent being acquired—does that come up? Because it does have certain characteristics which would fit what acquirers would look for and I just wonder if that's ever out there in the market or in the headlines.
· Matt Reustle, Mark de Vos
[00:00:00] S0: This question will come a bit out of order, but the M&A thesis that I described within the business, I'm curious if this is ever a target of M&A in terms of them being acquired, Agilent being acquired—does that come up? Because it does have certain characteristics which would fit what acquirers would look for and I just wonder if that's ever out there in the market or in the headlines. [00:00:00] S1: I haven't seen that in the market, if I'm honest. It's hard for one of their direct competitors. Thermo Fisher would, I'm sure, love to buy them. Very acquisitive company. It's much larger. Probably could if it really wants to. I think the challenge would be you'd attract competition scrutiny. I struggled to see that one happening. Otherwise, we certainly hope they remain a sort of independent business. [00:00:00] S0: Yes. Don't get in the way of compounding. Well, this has been fascinating and I think you simplified some pretty complex topics, so I appreciate that. I can say that personally, the way that we close out these conversations are with the lessons that you could potentially take away and apply elsewhere as an investor. What would stand out from doing your research and your experience with Agilent that might be a takeaway for other investment work?
· Matt Reustle, Mark de Vos
[00:00:00] S0: Yes. Don't get in the way of compounding. Well, this has been fascinating and I think you simplified some pretty complex topics, so I appreciate that. I can say that personally, the way that we close out these conversations are with the lessons that you could potentially take away and apply elsewhere as an investor. What would stand out from doing your research and your experience with Agilent that might be a takeaway for other investment work? [00:00:00] S1: There's two that came to mind. The first one would be not to underestimate the quality of what sounds a boring business. If I was to tell you at the pub about a business that services lab instruments, you might be forgiven for telling me to move on. Actually, this is a fantastic business. 33% operating margins, growing high single digits with a really long growth runway as they grow that attach rate. Not to be underestimated. The other one would be that actually often it's better to be in the businesses that are supplying tools. In this case, the life science tools companies have outperformed the pharmaceutical sector hands down and Agilent is a testament to that. [00:00:00] S0: Picks and shovels has been working for almost 200 years now. Well, Mark, this has been an excellent conversation. It's been a pleasure. Thank you so much for joining us. [00:00:00] S1: Thank you.