Massachusetts-based Waters Corp. (WAT) is a pioneer of analytical workflow solutions involving liquid chromatography, mass spectrometry and thermal analysis innovations serving the life, materials and food sciences. The company's specialty measurement products are often applied to discovering new pharmaceuticals, assuring food/water safety and ensuring the integrity of chemical production.
Pharma represents the most extensive customer segment for Waters with a revenue share of 56% as of fiscal 2018. Global drugmakers like Bristol-Myers Squibb (BMY) and Pfizer (PFE) depend on Waters' analytical technologies throughout their R&D and manufacturing processes. The U.S., China and Japan are among the top three markets for the company, accounting for 28%, 18% and 7% of fiscal 2018 revenue, respectively.
We especially appreciate the installed-base model at Waters, which builds a predictable recurring cash stream. The company earned approximately 50% of its sales from instruments and the other half through after-market items, including consumables (i.e., chemistry), services and informatics.
In our view, the high switching cost of the installed base and the long-standing reputation in liquid chromatography (LC) and mass spectrometry (MS) technologies provide the majority of sustainable competitive advantages for Waters against major competitors in the space, including Agilent Technologies (A), Shimadzu (TSE:7701), Bruker (BRKR) and PerkinElmer (PKI). The company also possesses 3,000 issue patents with an additional 1,600 in application. Per the chart below, Waters consistently outperformed competitors in terms of return on invested capital, implying the management's skillful capital allocation as well as the existence of an economic moat. Please note the one-time impact due to the U.S. Tax Reform in 2017, causing the earnings to drop sharply.
We think that significant exposure to the health care sector, along with geographic diversification and a recurring revenue model, helps contain the recession risk for Waters. As displayed below, both sales and operating income were mildly impacted by the last two recessions.
In terms of returning value to shareholders, Waters does not pay a dividend, and instead relies on its share repurchase program. Over the past 10 years, the share count has been reduced by more 20%. In the chart below, we observe that the company recently accelerated its pace in buying back stocks, partially as a result of the U.S. Tax Reform. At the same time, the valuation (measured by EV/EBIT) climbed considerably.
We believe that continuous investment in R&D would contribute to a widening moat for Waters. The company has a great culture and strong track record of developing and launching innovative products through its integrated global R&D network. In a typical year, around 5% of sales, or 20% of earnings, are reinvested into the business.
Moving forward, Waters is expected to benefit from multiple favorable megatrends in the categories that it serves. For example, the pharmaceutical, food and environmental, clinical and biomedical research industries may all see mid-to-high single-digit growth, propelled by factors such as the rising complexity of biologic molecules (a growing concern in food safety), the aging population worldwide, increasing regulations and healthcare spending in emerging markets.
Disclosure: The mention of any stock in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Waters.
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