Agilent Still A Name Worth Owning

By Stephen D. Simpson, CFA | May 16, 2012 AAA

Even for companies with a solid record of performance, macro and sector worries can dominate the story to a large extent. That would seem to be the case with Agilent (NYSE:A), as worries about the recovery in electronic test and measurement and the health of the life sciences market weigh down the shares of what is otherwise a very interesting and well-run company. Although Agilent may not be the best pick for investors who want to make a fast buck, investors with a long-term inclination should take a deep dive into this story.
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Good Results and Even Better Orders
Agilent did pretty well relative not only to Wall Street expectations, but to many of its peers and comparables as well.

Revenue rose about 3% as reported or 4% on an organic basis, just edging out a bit above the average estimate. Sales growth was led by the electronic measurement business, which grew 5% organically. Chemical analysis saw a 3% growth, while life science was the laggard at 2% organic growth.

Despite some slight (70 basis points) erosion in GAAP gross margin, Agilent did well in terms of expense control. SG&A and research and development both declined as a percentage of sales (and SG&A declined slightly in real dollars as well), allowing the company to post 13% operating income growth.

The real story coming out of the quarter is the order book. Orders rose 8% this quarter, giving Agilent a company-wide book-to-bill of 1.06 versus 1.02 a year ago. Order growth (and book-to-bill) was especially strong in electronic measurement (13% and 1.09, respectively), while order growth in life sciences was pretty poor.

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Is the Test Recovery Coming?
Agilent definitely reported stronger results and a more robust outlook in electronic test and measurement than did Danaher (NYSE:DHR) or the much-smaller EXFO (Nasdaq:EXFO), while overall trends were similar to National Instruments (Nasdaq:NATI). It's important to acknowledge that these are very different businesses with different customer and end-market exposures. That said, it looks like Agilent is seeing a broad-based recovery, with real signs of improvements in markets like communications, computers and semiconductors.

What's Next in Life Sciences?
Like Danaher and Waters (NYSE:WAT), Agilent reported pretty mediocre results in the life sciences business. What's a little unusual, though, is the revenue make-up. While Waters and Danaher both seemed to find a pretty tough market in biopharma, Agilent did reasonably well here.

At the same time, I wouldn't take the 6% decline in sales to academic customers as any particular read-through for companies like Life Technologies (Nasdaq:LIFE) or Illumina (Nasdaq:ILMN); Agilent's academic business is smaller, more capital equipment-intensive and more exposed to the declining microarray segment.

I do wonder, though, if the life sciences and/or chemical analysis segments might be getting a mergers and acquisitions boost soon. Agilent has a fairly sizable cash hoard and I believe the company would be more inclined to find a deal or two than return that cash to shareholders. A company like Bruker (Nasdaq:BRKR) or FEI (Nasdaq:FEIC) would look like a natural candidate to me, but I would be surprised if the company targeting sequencing or diagnostics.

SEE: A Primer On Investing In The Tech Industry

The Bottom Line
Part of the appeal of Agilent to me is that you don't have to be particularly aggressive with cash flow growth estimates to derive a pretty bullish fair value. In fact, mid-single digit revenue growth coupled with some improvement in free cash flow conversion is enough to produce a nearly 7% compound growth target for free cash flow. If that growth estimate is realistic, fair value today would seem to sit well into the $50s.

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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