SSB on Wat:
Waters Corp. (WAT)
WAT: Reports Better than Expected 4Q02 1H (Outperform, High Risk)
Results Mkt Cap: $2,885.8 mil.
January 28, SUMMARY
2003 * Following the pre-announcement of a shortfall in 4Q02
results in mid-December, Waters reported better than
BIOTECHNOLOGY expected 4Q02 results this morning. EPS of $0.41 before
-- LIFE unusual charges was higher than our estimate of $0.38 and
SCIENCES TOOLS above street consensus of $0.39, as sales of HPLC products
Lakshmi R accelerated at the end of the quarter, above the company's
Bhojraj previous expectations. Revenues of $256 million (up 3%)
were above our estimate of $240 million (down 3%).
* The company provided updated 2003 revenue and EPS
guidance. Revenues are expected to grow 6% ex-currency (9%
with currency) while EPS was guided to $1.43, $0.01 below
our estimate but $0.04 above consensus.
* We believe 2003 should be a better year for WAT, driven
by a new product introduction in the mass spectrometry
business in mid-2003, mid single digit growth in the HPLC
business, and improved trends in the thermal analysis
business. We continue to rate the shares 1H and the sector
Underweight.
FUNDAMENTALS
P/E (12/02A) 17.3x
P/E (12/03E) 15.1x
TEV/EBITDA (12/02A) NA
TEV/EBITDA (12/03E) NA
Book Value/Share (12/02A) $4.99
Price/Book Value 4.3x
Dividend/Yield (12/02A) NA/NA
Revenue (12/02A) $890.0 mil.
Proj. Long-Term EPS Growth NA
ROE (12/02A) 31.0%
Long-Term Debt to Capital(a) NA
WAT is in the S&P 500(R) Index.
(a) Data as of most recent quarter
SHARE DATA RECOMMENDATION
Price (1/28/03) $21.60 Current Rating 1H
52-Week Range $38.89-$17.97 Prior Rating 1H
Shares Outstanding(a) 133.6 mil. Current Target Price $25.00
Convertible No Previous Target Price $25.00
EARNINGS PER SHARE
FY ends 1Q 2Q 3Q 4Q Full Year
12/01A Actual $0.28A $0.29A $0.28A $0.39A $1.23A
12/02A Current $0.27A $0.28A $0.29A $0.41A $1.25A
Previous $0.27A $0.28A $0.29A $0.38E $1.22E
12/03E Current $0.30E $0.32E $0.35E $0.46E $1.43E
Previous NA NA NA NA $1.44E
12/04E Current NA NA NA NA $1.60E
Previous NA NA NA NA $1.60E
First Call Consensus EPS: 12/02A $1.22; 12/03E $1.40; 12/04E NA
OPINION
This morning, Waters reported fiscal 4Q02 results that were better than our
revised estimates following the pre-announcement of a shortfall in 4Q02
results in mid-December. Operating EPS of $0.41 were $0.03 above our
estimate and $0.02 above consensus. Revenues of $256 million (up 3%) were
above our estimate of $240 million (down 3%) with currency adding 4% to top
line growth and between $0.01-$0.02 to EPS. HPLC sales (up 4-5% including
currency, 2% ex-currency) were boosted at the end of the quarter by stronger
than expected demand from the industrial segment of the market, which offset
weakness in customer spending at the large pharmaceutical accounts. While
this was clearly a positive in the quarter, a full recovery in the HPLC
business is dependent upon a pick-up in the pharmaceutical end market. The
company is optimistic that this will occur in 2003 but is factoring in a
conservative mid to high single digit growth rate for the year, below market
growth of 7-8%. The mass spectrometry business was down 6-7% in the quarter
(-10% ex-currency), in line with our expectation, due to the company's
handicapped status following the loss of the patent litigation with Applera
in March 2002. The thermal analysis business was surprisingly strong, up in
the low double digits versus our expectation for mid single digit growth.
2003 Financial Guidance: The company provided updated financial guidance for
2003 (which had been put under review following the pre-announcement in mid-
December). Revenue growth is expected to be 6% ex-currency (9% with
currency) while EPS has been guided to $1.43, plus or minus the normal
tolerance of 4-8c. HPLC sales are expected to be up in the mid to high
single digits, mass spectrometry flat (due to the newly announced divestiture
of the inorganic mass spectrometry product line, which is expected to
contribute $14-$15 million to the top line and was operating at breakeven
profitability), and low single digit growth in the thermal analysis business
excluding the Rheometric acquisition, which should add approximately $19-$20
million to the top line. We are lowering our revenue estimate to $936
million from $945 million to reflect the divestiture of the mass spectrometry
product line and are not factoring in a currency benefit to the top line.
Our EPS estimate has been revised down to $1.43 from $1.44 to reflect the new
guidance.
Opinion: 2002 was a particularly difficult year for Waters as the company
grappled with a patent litigation loss to competitor Applied Biosystems,
struggled with variable trends in customer spending throughout the year in
its core HPLC business, and implemented a salesforce integration in its HPLC
and mass spectrometry businesses. In spite of the resulting P&L impact,
Waters was able to achieve strong cash flow generation, with approximately
$190 million in free cash flow generated for the year. The company has also
been undertaking an aggressive share buyback program as part of its 2 year
$200 million share buyback program initiated last year and purchased $100
million worth of stock in 2002. We continue to believe 2003 should be a
better year for the company, aided by a new product introduction in the mass
spectrometry business in mid-2003 (with shipments to begin substantially in
3Q03), mid single digit growth in the HPLC business and improving trends in
the thermal analysis business. In addition, the salesforce integration
should result in cost savings of approximately $6-$8 million on the SG&A line
in 2003. We expect that the company will continue to generate strong free
cash flow and likely complete the remaining share buybacks under its
authorization this year. We continue to rate the shares 1H.
SUMMARY OF 4Q02 FINANCIALS
Revenues
Waters' revenues are derived from three end markets: HPLC, mass spectrometry,
and thermal analysis, which comprised roughly 64%, 28%, and 8% of FY02
revenues, respectively. Total revenues of $256.4 million were above our
estimate of $240 million (which was revised down from $254.5 million after
the pre-announcement in December), and represented growth of 3% (-1% ex-
currency) from the prior year. HPLC sales (up 4-5% including currency, 2%
ex-currency) were boosted at the end of the quarter by stronger than expected
demand from the industrial segment of the market, which offset weakness in
customer spending at the large pharmaceutical accounts. While this was
clearly a positive in the quarter, a full recovery in the HPLC business is
dependent upon a pick-up in the pharmaceutical end market. The company is
optimistic that this will occur in 2003 but is factoring in a conservative
mid single digit growth rate for the year, below market growth rate of 7-8%.
The mass spectrometry business was down 6-7% in the quarter, in line with our
expectation, due to the company's handicapped status following the loss of
the patent litigation with Applera in March 2002. The company's current
expectation is that it will release the new next-generation triple quadrupole
system in mid-2003 with shipments to begin substantially in 3Q03, which
should result in a 2H03 recovery in the mass spectrometry business. In
addition, Waters announced the divestiture of its inorganic mass spectrometry
product line, which was expected to contribute approximately $14-$15 million
to the top line and is operating at breakeven profitability. The combined
impact of a stronger 2H03 from the new product introduction and the
divestiture of the inorganic mass spec product line should result in flat
growth (constant currency) for the mass spec business for the full year. The
thermal analysis business was surprisingly strong in 4Q02, up in the low
double digits versus our expectation for mid single digit growth. However,
we remain cautious about prospects in this business and are forecasting low
single digit revenue growth (prior to the addition of approximately $20
million from the Rheometric Scientific acquisition), in line with company
guidance.
Operating Expenses
Beginning in the fourth quarter, the company reclassified some service costs
from SG&A into COGS in an effort to be more consistent with industry norms.
This reclassification has no net impact on the income statement but has the
effect of making gross margins look lower and SG&A margins better than in the
past. In 2003, we expect gross margins to improve by 50 bp from restated
2002 levels and SG&A spending to grow below sales growth. We note that the
company expects to achieve cost savings of approximately $6-$8 million from
the recent integration of the salesforce in the HPLC and mass spectrometry
businesses and will continue taking charges as it identifies new cost
reduction opportunities. We expect R&D as a percentage of sales in 2003 to
be similar to 2002 levels at approximately 5.7%.
Earnings
4Q02 EPS of $0.41 was $0.03 above our estimate and $0.02 above consensus of
$0.39. Currency benefited EPS by $0.01-$0.02. In 2003, we are forecasting
EPS of $1.43, in line with the company's updated financial guidance, which
represents growth of 15% from the prior year.
VALUATION
For our relative valuation analysis, we used a P/E methodology to value
Waters shares as the company is a profitable, growing enterprise. For our
comparable peer set, we have chosen PerkinElmer, Pall, Applied Biosystems,
Amersham, Thermo Electron and Varian, each of which sells a mix of
instruments and consumables to a similar customer base. As shown in Figure
1, on a P/E basis, Waters is trading at 15x our 2003 projection, versus the
group multiple of 14-17x. When applying a multiple of 17x (at the high end
of this range and in line with closest peer Applied Biosystems), to our
revised 2003 EPS estimate of $1.43, we arrive at a price target of
approximately $25, which we believe represents attractive upside potential
from current levels.
Figure 1: Waters Relative Valuation
EPS P/E
Company Name Rating Price 2001 2002E 2003E 2003E
WAT WATERS CORP 1H $21.63 $1.27 $1.25 $1.43 15.1x
PKI PERKINELMER 2H $7.95 $1.09 $0.40 $0.52 15.3x
ABI APPLIED BIOSYS 3H $17.19 $0.90 $0.82 $1.00 17.2x
AHM* AMERSHAM 1H $38.03 $2.16 $2.38 $2.59 14.7x
PLL PALL CORP NR $16.67 $0.92 $0.86 $1.10 15.2x
TMO THERMO ELECTRON NR $15.30 $0.91 $0.98 $1.11 13.8x
VARI VARIAN INC NR $29.54 $1.35 $1.52 $1.75 16.9x
GROUP AVERAGE (EXCL 16.0x
WAT)
Salomon Smith Barney and First Call calendarized estimates.
*Covered by SSB London Analyst Jeremy Green.
RISKS
Currency Exposure
Waters has significant currency exposure. In 2001, Waters derived
approximately 57% of its net sales and 67% of its income before taxes from
outside the U.S. Although Waters uses debt swaps and forward foreign
exchange contracts to mitigate currency impact, the company remains
vulnerable. In 2001, currency shaved approximately 3% from the top-line. In
Q2 2002, however, currency trends began to change in the company's favor with
a significant weakening of the dollar relative to the Yen and the Euro.
Vulnerability to Customer's R&D budgets
Approximately 70% of the company's revenues are derived from instruments and
approximately 28% are from mass spectrometers, which can be as expensive as
several hundred thousand dollars apiece. While the mass spectrometry
business has been relatively shielded from this phenomenon compared to other
types of instrumentation (the larger issue for Waters has been the litigation
with Applied Biosystems), we believe a protracted slowdown in
biopharmaceutical R&D spending could have an adverse effect on this business,
which derives roughly 80% of its revenues from the non-academic sector. |
