Synthetic biology is making significant strides in addressing challenges in medicine, manufacturing, and agriculture. This presents promising opportunities for companies like Thermo Fisher Scientific (TMO), a global provider of life sciences solutions, analytical instruments, specialty diagnostics, and laboratory products. However, the market is underestimating its growth potential. In today’s FA Alpha Daily, let’s examine what the market is missing and what makes Thermo Fisher an excellent investment opportunity.
FA Alpha Daily:
Thursday Uniform Accounting Analysis
Powered by Valens Research
The pace of innovation keeps increasing.
This is not shocking to see. Companies are aware that higher returns are achievable only through innovation and offering better solutions than competitors.
That is why the total global spending on research and development hits a new record every single year.
When you look at the same number as a percentage of GDP, you will see that this is not only overall GDP increasing, but the proportion we allocate to research increases.
The R&D spending as a percentage of GDP was 2.1% in 2000, this grew to 2.7% over the last two decades.
While the ones mentioned with this surge are mostly technology companies and the AI field in particular, that is not the only place to look at.
Innovation in the healthcare world is also accelerating impressively, in particular with companies that are helping extend life using synthetic biology.
Synbio combines engineering with biology to develop new biological parts, devices, and systems found in nature. Many synthetic biology solutions are used in medicine, manufacturing, and agriculture.
The key thing for all this to happen is that you need the equipment for it to work.
That is where Thermo Fisher Scientific (TMO) comes in…
The company provides life sciences solutions, analytical instruments, specialty diagnostics, and laboratory products internationally.
One can understand how stable the business is just by reading what they sell.
All synthetic biology companies need their products. With its operating scale, Thermo Fisher is one of the easiest-to-reach shops for them.
That is why the company has a stable return on assets (“ROA”) of above 30%. This ratio surged to 41% as companies bought more products in search of a vaccine for Covid-19. Now, it is back to 35%.
Thermo Fisher operates in an only growing market looking at the R&D spending numbers and is in a great position to benefit from this trend.
However, we need to understand what the market thinks to understand if this can be considered an investment opportunity.
We can see this through our Embedded Expectations Analysis (“EEA”) framework.
The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.
In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.
At around $525 per share, the market is expecting the company’s ROA to fall below 30%, which would mean the business will structurally be a lower-profitability one.
This seems unlikely considering the company’s strong positioning in the industry.
If R&D spending continues to surge, Thermo Fisher Scientific will be one of the first to see increased demand and improve the business.
The market’s expectations seem overly pessimistic, which could mean an upside opportunity.
SUMMARY and Thermo Fisher Scientific Inc. Tearsheet
As the Uniform Accounting tearsheet for Thermo Fisher Scientific Inc. (TMO:USA) highlights, the Uniform P/E trades at 23.6x, which is above the corporate average of 18.4x but around its historical P/E of 23.3x.
High P/Es require high EPS growth to sustain them. In the case of Thermo Fisher Scientific, the company has recently shown a 13% shrinkage in Uniform EPS.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Thermo Fisher Scientific’s Wall Street analyst-driven forecast is a 3% EPS shrinkage in 2023 and a 15% EPS growth in 2024.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Thermo Fisher Scientific’s $519.75 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to grow by 11% annually over the next three years. What Wall Street analysts expect for Thermo Fisher Scientific’s earnings growth is below what the current stock market valuation requires in 2023 but above its 2024 requirement.
Furthermore, the company’s earning power is 5x its long-run corporate average. Moreover, cash flows and cash on hand are 1.5x its total obligations—including debt maturities, capex maintenance, and dividends. Also, the company’s intrinsic credit risk is 40bps above the risk-free rate.
All in all, this signals low dividend risk.
Lastly, Thermo Fisher Scientific’s Uniform earnings growth is in line with its peer averages and its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
The Uniform Accounting insights in today’s issue are the same ones that power some of our best stock picks and macro research, which can be found in our FA Alpha Daily newsletters.