Life sciences supplies powerhouse Thermo Fisher Scientific (TMO +0.32%) will report earnings tomorrow, giving investors a fresh look at the business. In preparation, let's dig into highlights from management's last quarterly conference call. Remember, as long-term investors, we're not so concerned with short-term beats and misses, so a meticulous investor can learn a lot about Thermo's long-term future by dissecting management's comments.
The major growth prospect
In terms of next gen sequencing, there is a lot of buzz around the PGM these days because there is work in the clinical trials area for oncology using the platform for matching patients to the right drug for various cancer types. -- CEO Mark Casper
Casper has it right -- clinical genomics is a massive growth market, and Thermo Fisher is a prime contender in the space. The new trend in oncology is drugs that target specific molecular signatures of tumor cells, which may be different between patients. These drugs will therefore require companion diagnostic tools to guide clinical trial design and patient treatment, and will be a critical component of the oncology revolution. Thermo's February acquisition of Life Technologies gives it direct access to this market, where its Ion PGM Dx system recently completed listing with the FDA for clinical next-generation sequencing.
New "Life" on multiple fronts
We now expect [Life Technologies] to achieve $100 million in synergies in 2014, up from the $85 million in synergies we originally anticipated. So we're pleased to report that we are achieving the first $100 million at a faster pace and we remain confident in our overall synergy target for year three which we increased from $300 million to $350 million at our analyst meeting back in May. -- Casper
The acquisition of Life Technologies doesn't only bring growth in new markets, but also significant cost-cutting synergies. One of the most significant synergies may be within the sales and distribution channels. Management highlighted Life's strong e-commerce presence and the desire to apply that experience to Thermo's core businesses. Life Technologies already operated with stronger margins, so adopting key operating strategies and cutting redundencies could boost Thermo's margins even higher. Those efforts appear to be ahead of schedule.
More government funding, more problems
In the academic and government end market, we saw improvement in Q2 with growth in the low single digits. We said last quarter that we thought funds would begin to flow in the U.S. under the new appropriations. And that seems to be playing out. -- Casper
In 2013, academic and government customers represented 27% of total sales. With the sequester and NIH budget questions seriously threatening a substantial revenue stream, management has been closely watching the public funding landscape. Growth for the last several years has been driven by strength in the biopharma industry, but it appears that academic spending may be recovering. The NIH received a 3.5% budget increase in 2014 after a 5% decrease in the 2013 sequester.
Government spending in the U.S. wasn't the only issue covered. Results from China were mixed.
China was flat year over year, resulting in Asia Pacific growth in the low single digits. Our China bookings performance in the quarter was much stronger than revenue and was up in the high teens. As a result, we're confident that revenue growth in China will be much stronger in the second half resulting in high single-digit growth for the full-year. -- CFO Peter Wilver
In its 2013 Annual Report, Thermo lists growth in emerging markets as one of three important areas of focus. China is a major target for Thermo, especially as economic growth brings demand for food safety and environmental applied analytical instruments. Delays in Chinese government spending hurt short-term sales, but strong bookings growth suggests important in-roads for the future.
Capital allocation is key
Obviously, we're driving our cash flow hard, we're focused on debt repayment. This company is focused on creating shareholder value. If we can get [to debt of 2.5 or 3 times EBITDA] sooner, we will but just as we modeled it out right now we think Q3 [2015] is a reasonable assumption. -- Casper
Thermo is very particular with its capital allocation, and wisely so. The company is fairly deeply leveraged at the moment, with total debt/EBITDA sitting at 4.6. Management has committed to reducing that value to 2.5 or 3 in the second half of 2015. I will be keeping a close eye on this metric in the meantime. When this goal is finally achieved, management will be free to apply cash to other avenues, like increasing its dividend payout above its current level of 16% of earnings.
The bottom line
Thermo Fisher's core business isn't particularly fast-growing, but comments from management suggest that academic funding is stabilizing, and that cleaning the balance sheet is a top priority. The exciting part of the business, though, is the prospect of genomics and emerging markets growth. Going forward, watch to see if Life Technologies will help Thermo thrive on both fronts.
