Strong margins and attractive yields give Avantor a competitive edge
New York-listed Avantor Inc is a global provider of mission-critical products and services to customers in the biopharma, healthcare, education and government, and advanced technologies and applied materials industries. Its products and services are used in virtually every stage of the R&D and production activities of the industries it has a presence in. Avantor also supplies chemicals for vaccine development and manufacturing, including solutions that support Covid-19 vaccines.
Our case for Avantor is that it not only benefits from the pandemic as being part of the vaccine value chain, but also has a strong business with good prospects stemming from demand within the biopharma sector. Besides supplying products and services to its customers, Avantor is involved every step of the way, ranging from scientific discovery to commercial delivery. The company’s business model includes high recurring revenues and strong cash flow generation through its customised solutions to clients and its e-commerce platform.
Avantor mainly segments its revenue geographically for its quarterly earnings. In the most recent 3Q2021 earnings, 60% of its earnings derived from the Americas region, 30% from the Europe region and the rest from the Africa, Middle East and Asia region.
Product group-wise, 35% is derived from proprietary materials and consumables, 40% from third-party materials and consumables, around 10% from services and specialty procurement, and the rest from equipment and instrumentation.
Customer group-wise, in the latest FY report, 50% of its revenue comes from the biopharma industry, 25% from advanced technologies and applied materials, 15% from education and government, and the remaining 10% from healthcare.
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The company’s business model is well diversified not just geographically, but also product- and customer group-wise, and we believe this feature is important for companies such as Avantor not to solely rely on a single source of income due to the network effect.
For Avantor’s year-to-date key financial performance metrics comparison, adjusted ebitda was up 32.5%, adjusted EPS 75.5% and free cash flow 4.1%. Guidance-wise, for the full FY2021, it was revised upwards after the most recent quarter for all three financial metrics; with organic sales growth from mid-single digit to double digits, adjusted EPS from 30% growth to 55% growth, and free cash flow from US$800 million ($1.08 billion) to US$850 million.
Avantor’s strategy includes M&A of companies within the value chain, for example the most recent announcement about its acquisition of Masterflex. Masterflex is a global leader in peristaltic instruments and aseptic single-use fluid transfer technologies for bioproduction. Avantor deployed US$4 billion of capital for this purpose during 2021, and is expected to deploy twice the amount through 2025.
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Avantor’s core business is led by biopharma, with Covid serving as a tailwind, driven by vaccine contributions. Its growing order book provides good earnings visibility, aided by its global presence — with market intelligence indicating a forecast of over 7% CAGR through 2026 for the biopharma industry.
Along with Masterflex, Avantor’s acquisition of RIM Bio and Ritter GmbH recently is expected to aid in margin expansion over the upcoming financial periods.
Some of the potential headwinds for Avantor include supply chain shortages and logistic delays, which has been a recurring concern especially during the pandemic. The company’s management has, however, said that they have this problem under control and have seen continued successes in navigating these issues, demonstrated by a healthy level of order book acceleration, which should also provide better earnings visibility in the upcoming periods. The company’s focus on M&A should also address this problem as it solidifies itself within the value chain.
Chart 1 illustrates the company’s margins over the past 12 quarters. The company’s strong cash flow margins stand out, along with its operating margins, indicating Avantor has a good competitive edge. In terms of financial safety, the company has a net debt to equity of 1.8 times, which could be a cause for concern. However, given the company’s strategy of deleveraging and its ability to generate cash, its financial safety should improve in the upcoming quarters.
Yields-wise, Avantor has an earnings yield, operating cash flow yield and free cash flow yield of 2.8%, 5.7% and 4.3% respectively, which is attractive compared to the risk-free rate of 1.9%. Compared to regional peers, the company trades at a 20% discount for its forward PE, and a 22% discount for its forward Ev/Ebitda. Globally, it trades at a 27% discount for its forward P/E and 26% discount for its forward Ev/Ebitda, implying that the stock is trading at an attractive price. Avantor has a stock beta of 1.11 times, indicating that the company is slightly volatile, and we think this is good for strong cash-flow-generating companies to realise their potential target prices.
Sentiments-wise, there are 16 “buy” calls and no “hold” or “sell” calls on the company from analysts. The average target price for the company is around 35% above its current trading price of US$34.74 as of Jan 28. Based on our in-house valuations, we think this company has the potential to hit upwards of 40% gains in share price over the next 12 months. It is rare that companies with strong cash-flow-generating potential trade at attractive valuations, and we think that Avantor’s main red flag of debt will be less of a concern in the upcoming quarters. This stock is for investors seeking growth with a medium-risk appetite.
