At first glance, Sigma-Aldrich (NASDAQ:SIAL) looks like just another stodgy Midwestern chemical company -- pretty boring stuff to most investors, myself included. But Sigma-Aldrich operates in the dynamic "life science consumables" space, against fast-growing competitors such as Invitrogen (NASDAQ:IVGN) and Fisher Scientific (NYSE:FSH). Sure, they sell chemicals, but those compounds are organic chemicals or biochemicals. Sigma-Aldrich also provides related equipment used and consumed in laboratories throughout the world. This stock offers exposure to a wide potential customer base, and a compelling way to invest in the space.
In Sigma-Aldrich's fiscal first quarter, sales grew 10.8%, with organic growth (sales from existing operations) representing all but 0.5% of the total. Acquisition-related growth represented an increase of 4.8%, but it was offset by a 4.3% negative currency impact due to a strengthening dollar. (Nearly half the company's sales are outside of the U.S.)
EPS results were a bit difficult to discern, due to a tax-settlement claim in last year's first quarter, but reported EPS topped consensus estimates at $0.98. Management also detailed full-year guidance, predicting EPS within a range of $3.80-$3.90 per share on 7% organic sales growth, with an additional 3% expected from acquisitions. The EPS figure includes stock option expense of $0.14-$0.16 per share.
Analysts were mostly unimpressed with the quarter's sales, believing that organic growth should have been higher, given the easy year-ago comparison. Until recently, Sigma-Aldrich's growth was a bit lackluster, but it appears to have picked up again lately. Still, several analysts question whether EPS growth will return to a consistent 10%-15% annually.
Let's take a long-term perspective on that question. Sigma-Aldrich's stock has killed the S&P over the past five years, gaining a reputation as a consistent grower over time. In the past five years, sales have grown about 10% per year, and earnings have grown near 16% annually. Using net income as the numerator, returns on equity and capital have averaged a strong 20% and 15% in the same time frame.
A fragmented and diverse customer base gives Sigma-Aldrich considerable pricing power. The company also enjoys international sales exposure and diversification and a continual share repurchase program. The stock yields 1.2%, and the debt-to-capital ratio is favorable at just under 20%.
Additionally, Sigma-Aldrich is exposed to industries that could be poised for robust growth. Aside from large-cap pharmaceuticals, health care remains a growth industry. Demographics are in its favor, and its research and development initiatives should continue to expand. Furthermore, Sigma-Aldrich competes in a fragmented industry, providing ample opportunities to supplement internal growth with acquisitions, as management has successfully done in the past.
In valuation, Sigma-Aldrich's P/E multiple is reasonable at roughly 18.5 times trailing earnings, and about 16.2 times next year's consensus earnings. The five-year P/E range is approximately 16-28, placing the current multiple at the low end of the range. Then again, growth expectations aren't as robust as they were in 2000.
Calculating a stock's implied growth rate can help gauge how much of that growth is already baked into its price. For Sigma-Aldrich, I calculate roughly $2.75 in free cash flow per diluted share for the last fiscal year, versus reported diluted EPS of $3.62. That means the company would have to grow free cash flow 14% per year to justify the current stock price. It's a high target, but not unreasonable, considering the company's track record. Major inputs include a 12% discount rate and 3% terminal growth rate.
As always, it's best to do a sensitivity analysis, but I believe that my model is conservative. I'm looking at trailing earnings, calculating amounts using fully diluted shares, and using free cash flow versus net income, and I haven't employed a transition growth period down to the terminal growth rate.
Sigma-Aldrich is a solid company with a strong historical track record and compelling growth prospects. The shares have had a nice run over the past year, from about $55 to around $68.39. Even at current levels, the shares may be worth picking up, since they appear fairly valued. I'm keeping an eye out for a dip below $60, in hopes of gaining some additional margin of safety -- just in case growth falls a bit short of expectations.
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Fool contributor Ryan Fuhrmann has no financial interest in shares mentioned in this article. Feel free to email him with feedback or to discuss the company further.
