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.

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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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Tickers in this Article: A, DHR, WAT, ILMN

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