Investment thesis
Bio-Rad Laboratories, Inc. (NYSE:BIO) is a multinational manufacturer and distributor of life science research and clinical diagnostics products. The company operates through two primary segments: Life Sciences (“LS”) and Clinical Diagnostics (“CD”), providing tools for biological research and clinical diagnostics.
Since FY’21, the company’s stock has been hammered due to a litany of pressures, not in the lest its position in German-listed Sartorius AG. That investment continues to be a drag on performance and returns on capital (end of the day, it is equity capital). The stock is -25% YoY and missed the FY’23/’24 rally in broad equities – clear indication of the market’s sentiment. I would say this pessimism could provide opportunities – but not with the stock still trading >20x EBIT with 1) lumpy operating earnings and 2) heavily contracted FCF per share vs. FY’21 – where it traded >45x EBIT by the way.
This is a name I know extensively well having covered it 7x here on Seeking Alpha since FY’20 (see the original thesis here, and the most recent one here for reference points).
Having relied on the Sartorius position to post gains in market value from FY’18–’21, an honest appraisal of the business and its intrinsic value without this factor is required.
Despite numerous updates to my modelling, I am hold on BIO due to 1) abysmal returns on capital [I’m including Sartorius in all numbers to penalize BIO for this investment – it must be indexed as capital invested in my view], 2) weakening fundamentals [margins are <600bps vs. FY’21 whilst capital turnover is flat at ~0.2x] and 3) valuations unsupportive with the stock still running at >20x EV/EBIT, but looking at multiples of capital is <1x EV/IC. This divergence is clearly a risk to the downside in my view. Reiterate hold.
Figure 1.
BIO business characteristics
Firstly we can’t ignore the recent departures of key executives including the COO and the CFO in the last quarter. Regarding this, the CEO had this to say on the Q1 FY’24 earnings call:
We have received questions about management turnover and succession in the last six months. I thought it would be useful to say a few words. So, in short, as I think about it, each of these discrete departures is really centered around personal decisions either related to other opportunities or, or retirement.
From my perspective, it’s all part of a normal progression for these individuals and for the company.
Take what you will from that but from my perspective the “discrete departure” of two executives would have deserved a little more explanation. Nevertheless, it was another challenging quarter for the business:
- Sales of $610.8mm were –9.8% YoY and –9.6% in CC. Gross margins compressed ~10bps YoY to 53.4% on lower revenues and lower margin product mix.
- The LS segment did $241.7mm of business, down ~25% YoY due ongoing weakness in its biotech and biopharma end markets. But this is compounded by weak sales in China – a bet management has yet to pull off [this is despite the Chinese Gov’t stimulus recently announced there].
- Meanwhile CS sales were +470bps YoY to $368mm, underscored by demand in its diabetes markets.
- Management sees ~100–250bps YoY sales growth on 13-14% pre-tax margins [these are ~1% and up to 600bps below 5-year averages, respectively].
Potential catalysts
Despite lumpiness in process chromatography sales management converted early customers from competing resins to its platform in Q1 2024. This could be a long-term lever for BIO, especially as 1) management says no customer losses were reported and 2) it is maintaining market share.
Added to that, is has a number of product launches in its LS business for FY’24, namely:
- ChemiDoc Go platform in Q2 ’24.
- Single-cell sample prep solution in Q2 ’24.
- QX Continuum back end of ’24.
These are the two major catalysts I view right now. As you can see, they are far and few between as management first needs to stabilize sales in the LS segment.
Unattractively valued
Whilst it trades >20x EBIT and >31x NOPAT (TTM values) capital that’s been employed into then invested by BIO is worth <100 cents on the dollar. My view it is worth ~$240–$250/share today at ~23x NOPAT or 0.7x EV/IC.
BIO trades at ~0.7x book capital despite the high multiple on earnings (Figure 2). Note this includes Sartorius for 2 reasons, 1) as it is shareholder/debtholder capital invested and at risk in BIO’s ‘operations’ at the end of the day, and 2) all EV multiples include it in the calculus anyway. The primary reasons behind the <1x valuation is (i) BIO’s abysmal ROICs [<3% on rolling basis], and (ii) underwhelming business drivers.
Figure 2. Book capital valued ~70 cents on the dollar.
Valuation insights
I start with the company’s business drivers:
- I would repeat, it is highly unusual for a company with <15% 5-year avg. EBITDA growth and contracting margins to trade >30x NOPAT as BIO does. More so, post-tax margins are down ~600bps from 15.7% in FY’21 to ~9.9% with capital turns ~0.2x (Figure 3). Thus, management’s investments now bring in $0.20 on the dollar and produce ~$0.02 on the dollar in NOPAT.
- The issue is management continue throwing huge sums of cash back at the business, reinvesting at these <3% returns. Imagine giving money to a fund manager, only for them to invest in high-risk securities (just like business assets are) to produce <3% – when the indices do +10-12% annualized. You’d be unhappy right? You’d probably value that capital at less than 100 cents on the dollar, seeing as if you invested there, you’d be leaving ~700-900bps p.a. on the table on average. Hence my view is 1) the market has BIO priced correctly at 0.7x capital, and 2) it may continue to trade ~this level, but won’t create economic value given these business returns.
Figure 3.
- The result of the ~600bps margin contraction is an equally sharp contraction in FCF/share – from ~$22/share in FY’21 to <$$6.50 share in the last 12 months. There’s been some normalization in the trend (Figure 4) but it isn’t throwing off piles of cash vs. current market capitalization [$6.41 FCF/share yields ~2.1% at current share price of ~$295.50]. Thus pay ~30x NOPAT for (i) capital valued <100 cents on the dollar, due to (ii) earning <3% on this capital, meaning (iii) FCF is not highly available and being reinvested at these abysmal rates. This supports a hold.
Figure 4.
- My view is that sales will avg. ~1.5-3% [I’ll run with 1.5% on the conservative side] with ~18% pre-tax margins [generous] and ~$0.50-$0.60 investment to produce a new dollar in sales (Figure 5). This gets me to ~$344mm in NOPAT this year [see: Appendix 1], stretching to ~$370mm by FY’26E. Here I see ~24% growth in NOPAT this year [off a low base] and fade this down to ~3%, with ROICs of ~3% throughout [giving BIO +100bps of ROIC to work with – if it can’t demonstrate an increase value with that, it is an issue]. At ~0.7x my FY’24–’26E estimates of BIO’s invested capital this gets me to ~$243/share implied market value, ~17% downside from current range (Figure 6).
- On the upside, if the multiple expands to >1.2x IC, then we get to ~$323/share implied value (~9.5% upside) but for this to happen, we need (a) ROICs >8-10% and (b) pre-tax margins of >30% to make it happen. These are both low-probability events in my view [BIO’s 5yr avg. ROIC is <3% and 5yr avg. EBIT margin is 15% – do I think it is more profitable than 5yrs ago, to see it push to these levels? Answer is: No].
- In short, BIO still appears overvalued in my view, and even stripping Sartorius’ influence on its stock price, the business’s returns aren’t sufficient.
Figure 5.
Figure 6.
Risks
The upside risks to the thesis are 1) BIO producing >3% sales with 25% pre-tax margins – this could lift ROICs to +6% and see it potentially trade at ~1x EV/IC, 2) Sartorius position catching a strong bid, and 3) earlier rates cut which is a tailwind to equity valuations.
In short
BIO remains a hold in my view due to 1) its <3% ROICs on a recurring basis, 2) potential catalysts in product launches this year, and 3) valuations implying further downside to ~$245/share. Fact is BIO is trading >30x NOPAT despite softening fundamentals which is highly unusual, as such the calculus remains skewed to the downside in my view. Reiterate hold.
Appendix 1.
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