It may not look like it on the basis of the last few quarters, but Agilent (NYSE:A) is getting better. Weakness in multiple test and measurement end-markets and lower government spending are generating stiff headwinds, but the company continues to roll out strong new products, and the long-term potential in chemical analysis and diagnostics remains impressive. Even though Agilent is near a 52-week high, I believe shareholders could still do reasonably well with this stock, particularly if their investment horizon is more than just a quarter or two.
Fiscal Q3 Results Look Ugly
On an absolute basis, it's tough to sugar-coat Agilent's third quarter results. Revenue was very slightly above expectations, but still contracted 6% on an organic basis. That grim result was led by Electronic Measurement (EMG), where revenue fell 16% on an organic basis (and was still down 8% after adjusting for a large customer loss). Results were better on the other side of the fence, were both Chemical Analysis and Life Sciences delivered low single-digit growth (3% and 4%, respectively) and Diagnostics revenue rose 7%.
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Non-GAAP margins and profits were under pressure, but came in okay relative to sell-side targets. Gross margin rose more than a half-point, while operating income declined 13%.
Still Waiting For EMG To Turn
This wasn't a great quarter for test and measurement companies like Danaher (NYSE:DHR), JDSU (Nasdaq:JDSU), and EXFO (Nasdaq:EXFO), but Agilent's performance was worse than the average. While the loss of that wireless test customer definitely hit results hard, the 11% decline in the computer and semiconductor markets was pretty painful as well. It does seem as though these businesses may be bottoming, though, and the company did see some growth in aerospace on strength in satellite components.
Government spending declines in the U.S. are also pressuring the life sciences and chemical analysis businesses. Academic/government spending was down 7% in part due to sequestration, but I think it's worth noting that others like Waters (NYSE:WAT), Thermo Fisher (NYSE:TMO), and Illumina (Nasdaq: ILMN) seem to be withstanding these pressures better. On the other hand, the company's relatively low exposure to academia and government is often cited as an investment positive, so I wouldn't read all that much into it for the long-term. Moreover, short-term disruptions need to be evaluated in the context of strong long-term opportunities in food safety, environmental and other markets.
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Diagnostics Looking More Promising
Getting Dako back up to cruising speed is still going to take some time, but Agilent seems to be making good progress. Internal sales growth has been better than a lot of analysts expected at the time of the deal, and new products like an impressive autostainer suggest an opportunity to regain ground from others like Danaher and Abbott Labs (NYSE:ABT).
It's also worth noting that Agilent's potential in diagnostics isn't tied just to Dako. Technologies like mass spec are becoming increasingly relevant in the clinical diagnostic market, and Agilent not only has a good foundation in the hardware side, but also a realization that better software is going to be increasingly important as this market comes into its own.
The Bottom Line
With Danaher having outperformed Agilent over the last year and looking a little pricier relative to fair value, it may time to favor Agilent again. I believe Agilent can grow its top line by 4% or more over the long term, and improve margins to drive free cash flow growth of 7% or better. That translates into a fair value above $52.
Agilent isn't a dirt-cheap screaming buy, but the company has been doing better despite some pretty nasty headwinds outside of its control. That leaves me more confident that Agilent will come out of the turn with good momentum and the potential to exceed expectations.
Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.