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Exceptional Growth in the Research Supply Industry

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Almost anyone who ever worked in a biology or chemistry laboratory would recognize the logos of Thermo Fisher  (NYSE: TMO  )  and Sigma-Aldrich Corp  (NASDAQ: SIAL  ) – two of the biggest brand names in scientific research.

While these companies are best known for their exceptional products, they are also exceptional stocks that have been outperforming the S&P 500 for the last decade.

Since 2004, SIAL and TMO appreciated by 251% and 308% (respectively) while the S&P 500 only moved up by 73%.

If we go all the way back to 1994, we can see that SIAL and TMO appreciated by 905% and 620%-beating the 343% returns seen on the S&P 500.

Where is this outperformance coming from?
Digging into the historic financial data of these companies, one can easily find the market's rationale for these stocks' multi-decade, market-beating returns.

Sigma-Aldrich has been growing its revenues and incomes both consistently and predictably for decades, and the company has increased its efficiency significantly since 2004. Between 2004 and 2013, Sigma-Aldrich grew annual revenues from $1.4 billion to $2.7 billion. Meanwhile, operating income grew from $233 million to $491 million.

After a merger between Thermo Electron and Fisher Scientific in 2006, the new entity saw similar consistency in its growth other than one hiccup in 2009 when revenues dropped a bit. Between 2007 and 2013, Thermo Fisher grew revenues from $9.7 billion to $13.1 billion and operating income from $974 million to $1.6 billion.

Built-in competitive advantages
Although these companies are also forced to maintain an internal R&D budget to keep products up-to-date, the process heightens the industry's barrier to entry, and keeps research laboratories increasingly dependent on an increasingly specialized line of products.

It's also difficult for smaller competitors to undercut Thermo Fisher or Sigma-Aldrich on basic products (like reagents) now due to the efficiency of the supply chain built by these companies. Because these companies were never designed as brick-and-mortar suppliers, they adopted substantial supply chain efficiency from the get-go.

What threatens research suppliers like SIAL and TMO?
Companies like Thermo Fisher and Sigma-Aldrich continue to suffer from a decline in government R&D spending, especially in European countries that are cutting research funding due to austerity measures.

This hasn't been as big a factor in the United States, although austerity continues to threaten the growth of many industries connected to the government's budget. More R&D dollars do come from businesses and private entities, but public funding still supports ~1/3rd of scientific research in the United States.

There is, of course, always the impact of foreign currencies -- foreign laboratories use different currencies, and converting those back to U.S. dollars can have an impact on revenue and earnings.

The future for research vendors
It's impossible to guarantee that the growth in the research supply industry will continue, but the uptrend has been incredibly consistent throughout the last 20-30 years despite serious financial turmoil during the dot-com bubble and the 2008/2009 "great recession."

If austerity does threaten public R&D funding in the developed world, I believe that research suppliers will put much more emphasis on catering to private research entities (like pharmaceutical companies). This could lead to further consolidation in the research supply industry, based on the idea that big customers want big and well-known suppliers.

Based on its recent $15.3 billion acquisition of Life Technologies Corporation, it appears that Thermo Fisher it set on becoming the dominant force in the research supply industry. TMO already dwarfs the size of many competitors at its current $48 billion valuation, and it's still sitting on an extra $1.5 billion in cash and equivalents after the acquisition.

Will Thermo Fisher be looking to solidify its position with additional acquisitions – like the $12 billion dollar Sigma-Aldrich?

It seems plausible.

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