Thermo Fisher Scientific (NYSE: TMO) stock has recorded one of the most impressive performances among its diagnostics and research peers over the past several years. Despite shares correcting recently, Thermo Fisher is still up almost 200% over the past five years. The stock’s success story has been attributed to the company having masterfully combined organic and M&A growth that has resulted in unlocking magnificent economies of scale. That said, I believe that Thermo Fisher Scientific remains expensive. In the current environment, its valuation multiple is hardly justifiable, despite the company’s multiple qualities. Accordingly, I am neutral on the stock.
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What’s Driving Thermo Fisher’s Momentum?
Prior to the pandemic, Thermo Fisher was growing rapidly, but it was COVID-19 that gave a massive boost to its top and bottom line. As you may remember, diagnostic budgets skyrocketed globally between 2020 and 2021, and due to Thermo Fisher’s widened portfolio of diagnostic products and services, the company found itself in the perfect spot.
However, even with the pandemic fading, Thermo Fisher managed to retain its momentum. This is because the majority of its diagnostic services are not COVID-19-related; it’s just that they became more relevant during the pandemic.
The company took advantage of elevated profitability during the pandemic to acquire key companies through which it unlocked synergies and achieved economies of scale. For instance, exactly a year ago, the company acquired PPD, Inc. for $17.4 billion in cash. PPD is among the most predominant providers of clinical research services to the pharma and biotech industries all over the world.
Over this past year, the company has managed to cut costs and improve margins through such acquisitions, even as the pandemic-driven euphoria in the space waned. For context, Thermo Fisher’s last-12-month EBITDA margins currently stand at 28%, lower than their peak levels of close to 35% during the pandemic but notably higher than their pre-pandemic levels of 25%.
With its acquisitions adding to the top line and margins expanding, the company has not only managed to sustain relatively strong momentum, but its revenues and profits are set to hit new all-time high levels this year.
Set for Record Fiscal 2022 Results
Following Thermo Fisher’s Q3 results, the company is set to end the year with a record performance. As I mentioned previously, the company’s growth continues to be driven both organically and through the recent M&A. However, due to last year’s massive organic growth, organic growth marginally boomeranged this year.
Specifically, revenues advanced 14.4% to about $10.7 billion, broken down into organic revenue growth of -1%, revenue growth from acquisitions of 20%, and a 5% headwind related to foreign exchange. Still, organic growth coming in negative at -1% is truly impressive, as it actually indicates that the company retained the majority of organic growth achieved during the pandemic, and didn’t give it back, in which case organic growth should have come in at, say, -10%.
And again, while margins did decline year-over-year amid last year’s inflated demand for diagnostics, they still remain higher compared to their pre-pandemic levels. Its operating income margin came in at 22.2%, down from last year’s 29.8% but still significantly higher than Q3-2019’s operating income margin of 15.1%.
Despite the company facing heavy FX headwinds and organic growth unwinding, management expects record revenues for the year of $43.15 billion. That’s not necessarily impressive, as this year’s revenue growth is mostly acquisition-driven. However, it’s how accretive these acquisitions have been to scaling economics and earnings per share that’s the impressive part. Management expects adjusted earnings per share to land close to $23.01, suggesting another year of record profitability and year-over-year growth of 17.3%. That’s on top of last year’s growth of 21.9%.
Is TMO Stock a Buy, According to Analysts?
As far as Wall Street’s sentiment goes, Thermo Fisher Scientific has retained a Strong Buy consensus rating based on nine Buys and one Hold rating assigned in the past three months. At $618.43, the average Thermo Fisher Scientific price target suggests 10.8% upside potential.
Takeaway: A Steep Valuation That May or May Not be Deserved
Wall Street analysts continue to be quite bullish on TMO stock, as they have consistently been over the past few years. The fact that TMO stock has been a Wall Street darling, however, has led to it trading at quite an elevated valuation. Based on management’s guidance, the stock is trading at a forward P/E ratio of about 24x. A premium is partially deserved due to the company’s operating excellence, moat, and compelling growth. Nevertheless, with interest rates on the rise, investors ought to require a larger margin of safety, as the possibility of a valuation compression is not out of the question.
In that regard, there is a noteworthy chance that a part of Thermo Fisher’s future growth could be offset by valuation headwinds, which could limit investors’ total-return prospects. Hence, I will stay on the sidelines for now.
