Waters Corp refocuses on its strengths

To the untrained eye, one of Waters Corporation’s (US:WAT) liquid chromatography-mass spectrometry (LC-MS) systems could easily be mistaken for an office photocopier. The simple, boxy exterior of these machines belies the complex processes that take place within. Waters’ instruments are used in a variety of lab settings, from academic research facilities to pharmaceutical research and development (R&D) centres, to conduct bioanalysis. In practice, they’re often used by drug developers to ensure that their products are safe and meet exacting regulatory standards. 

“You could have a biopharmaceutical company that is evaluating a small molecule drug and they could have four liquid chromatography instruments, each doing a different task,” said Puneet Souda, a senior research analyst at SVB Securities. “Another application would be in a food lab, testing a soft drink to make sure the water that is being used has no metal impurities. These are highly sensitive instruments and their applications are wide.”

Around 90 per cent of the company’s revenue comes from the Waters division, which produces mass spectrometry and liquid chromatography tools, as well as related products. The remaining 10 per cent is generated by the thermal analysis business, which provides measurement devices for thermodynamic experiments (think tests of battery or circuit board performance). Put simply, Waters Corp makes tools that help scientists and researchers analyse the safety, quality and durability of consumer products.

Niche as some of the company’s instruments may sound, they’re clearly in demand across a number of industries, which is why Waters Corp was able to deliver organic year-on-year revenue growth of 15 per cent in the third quarter. On a recent earnings call, management said that the company’s order book was strong, and that orders were growing “faster than sales”, which is particularly encouraging given the darkening macro outlook. 

Whether the company can sustain this momentum into next year is less certain. Although it recently raised full-year revenue growth guidance to 11.5 to 12 per cent (up from 9.5 to 10.5 per cent previously), it cut its earnings per share forecast in anticipation of foreign exchange (FX) headwinds. Currency volatility is a material risk for the company, which makes about 40 per cent of its sales in Asia and a quarter in Europe. Gross margins for the full year are now expected to decline by 50 basis points to 58 per cent for the full year, with operating margins remaining flat at around 30.2 per cent.

Investors will be watching margins and earnings per share closely for signs that an in-progress “turnaround” initiative is yielding results. When current chief executive Udit Batra joined Waters Corp in 2020, the company had “lost its focus”, according to SVB’s Souda. “It was focused more on certain growing areas, and as a result its core [business] started slipping away,” he said. Batra aimed to reinvigorate the company through an instrument replacement drive, as well as strengthening its ecommerce and technology offerings.

Analysts at Stifel also believe the company is now benefiting from a cyclical rebound in its core pharmaceutical market. “At this point, it is too difficult to separate the cyclical recovery from the business transformation, but we expect clarity…as competition gets more challenging and Waters is given the opportunity to prove that the turnaround is producing tangible results,” they said. 

Ultimately, Waters Corp must gain back lost market share from rivals in the life science tools sector. This cohort includes Agilent (US:A), Thermo Fisher Scientific (US:TMO) and Danaher Corporation (US:DHR). According to SVB Securities, Waters’ peers trade on an average EV-to-Ebitda multiple of around 19 times, whereas it is slightly pricier at 19.6 times. 

Whether this price tag is justified depends largely on the progress of the company’s transformation, and its ability to navigate a worsening economic climate. Waters Corp may be enjoying its new lease of life for now – but the true tests of its mettle lie ahead.