When end-market conditions erode, there's not a lot that even the best companies can do apart from hunker down, hold the line on costs and keep building for the future. So although I'm sure that those traders and investors who focus on the short term will think I'm nuts, I still happen to think that Agilent (NYSE:A) is a quality company and that today's valuation is pretty appealing for long-term holders.
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Third Quarter Numbers Get Ugly Fast
Between Agilent's quarterly report and management's subsequent comments, it sounds like a lot of the company's end markets deteriorated further and faster than expected.
Revenue was up 2% as reported, down 2% in constant currency and up a bit more than 2% organic - well below the company's prior mid-single-digit guidance. Electronic measurement was down 1% from last year (flat organic) and down 4% sequentially. Chemical analysis was flat, as reported, up 3% organic and down 2% sequentially, while life sciences rose 2% as reported (5% organic) and fell 1% sequentially. The newly formed/reconstituted diagnostics and genomics segment saw 52% reported growth, with a 2% organic decline.
Margins don't look good, and objectively they weren't great, but I think they held up reasonably well overall. Gross margin fell by 70 basis points (both on a GAAP and non-GAAP basis), while operating income fell 4% on a reported basis, but rose 2% after stripping out items like acquisition costs.
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The Order Book - Things Are Tough out There
There's no question that conditions in many of Agilent's addressed markets have gotten more challenging. Orders fell 2% on an organic basis, resulting in a 0.96 book-to-bill. Every segment was down, with electronic measurement down on weak aerospace (defense) and industrial (autos and consumer electronics), while chemical analysis saw weakness in energy and petrochemicals. Given Danaher's (NYSE:DHR) comments regarding their test and measurement business, Agilent's experience doesn't seem out of the norm (the new norm, at least).
Life sciences was a little more encouraging. Big Pharma seems to be spending a little more, although academic markets are weak, and Agilent's sales there fell 6% this quarter. That's not going to be good news for Illumina (Nasdaq:ILMN), nor other life science tool and equipment vendors like Bruker (Nasdaq:BRKR), Thermo Fisher (NYSE:TMO) or Waters (NYSE:WAT).
Interestingly, Dako was pretty strong, with revenue up double-digits since Agilent's deal closed. As a reminder, Dako has solid share in pathology (particularly in areas like advanced staining) and is well ahead of Danaher and Abbott (NYSE:ABT) in that regard, but has stagnated due to a lack of product innovation. Although this quarter is encouraging, investors shouldn't get ahead of themselves on their expectations for Dako - the long-term potential is there, but as in the case of Danaher's purchase of Beckman, Agilent is going to have to invest time and money into Dako.
The Bottom Line
Agilent is a good company with solid brands, good market share and excellent returns on capital. However, it is not a perfect company; businesses like electronic test and measurement are not only cyclical, but the cycles are inconsistent and unpredictable. Agilent also doesn't always have the best reputation with all of its customers (some resent the money the company makes from service calls), though it seems that these customers continue to use and buy Agilent products anyway.
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I see no reason that Agilent cannot continue to grow its free cash flow at a healthy single-digit clip. That seems especially so when considering the emerging demand growth in markets like China, India and Brazil. With that sort of free cash flow production, fair value seems to lie in the mid-$50s which suggests that Agilent is not a bad stock to consider at these prices.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.