Bio-Rad Laboratories

Bio-Rad reported a second-quarter revenue decline of 1.9% year on year at constant currency, and non-GAAP operating margin fell 1.1 points to 12.5%. Management reiterated full-year guidance ranges for currency-neutral revenue change of negative 3.0% to 0.5% and non-GAAP operating margin of 10%-12%.

Why it matters: The result is in line with our expectation and shows modest sequential progress over the difficult first quarter. Management maintained wide guidance ranges to reflect ongoing uncertainty in China, the Middle East, and US academic research demand. Life sciences fell 5.1% on a currency-neutral basis due to weak US academic research markets and a high base of comparison in process chromatography (less than 5% of companywide sales). Excluding process chromatography, life science revenue was approximately flat, an improvement over the first quarter. Clinical diagnostics grew 0.3%, led by quality controls in the blood typing portfolio. Regionally, the Middle East rebounded to 7% growth, but China (about 6% of companywide sales) declined in the high teens due to the timing of quality control orders and weaker demand for life science instruments.

The bottom line: We maintain our fair value estimate of $280 per share for wide-moat Bio-Rad, and think the near-term uncertainty warrants caution. Bio-Rad's unconsolidated holding of wide-moat Sartorius AG shares contributes about half of our fair value estimate. Sartorius AG delivered 7.9% organic revenue growth and 30.8% underlying EBITDA margin in the second quarter, suggesting healthy demand from drugmakers for its bioprocessing products. Management announced a new restructuring program, including headcount reduction, facility rationalization, and investment in critical capabilities. It targets $30 million-$35 million in annualized net savings with an upfront pretax charge of $80 million-$90 million, which mostly consists of termination benefits.

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We maintain our fair value estimate of $280 per share.

We forecast annualized revenue growth of 1% over the next five years, reflecting slower growth in the life sciences business due to weak US academic markets and slower growth in the clinical diagnostics business due to escalating conflict in the Middle East and its adverse impact on demand from that region. We expect the non-GAAP operating profit margin to stay in the low teens, just above 10%. We expect research and development expenses to stay at 9%-10% of sales over this period.

Bio-Rad’s 33% equity stake in Sartorius contributes approximately 45% of our model valuation after subtracting the deferred taxes associated with its capital gains. We assume a price of EUR 241 per preferred share, which is Morningstar's fair value estimate as of this writing.

We use a 7.5% weighted cost of capital.

Bio-Rad has a wide economic moat supported by switching costs from an equipment installed base in clinical diagnostics, much of which is closed-loop systems that generate recurring consumables revenue, as well as its noncontrolling holding of wide-moat Sartorius shares. A secondary moat source is intangible assets related to its strong market positions in niche clinical diagnostic markets. The company is a leader in many of its product lines, with about 80% of sales from products in which Bio-Rad has a top market position. While current market strength does not guarantee future market leadership or shareholder returns, the diagnostic and life sciences markets tend to favor strong incumbents, as the complexity of instruments and analysis creates lasting system familiarity benefits for practitioners.

We see an economic moat in Bio-Rad’s clinical diagnostics business unit (about 60% of sales). This segment sells a variety of testing systems to hospital labs, reference labs, and transfusion labs that allow them to run in vitro diagnostics on patients’ tissue, blood, or urine samples. We consider the reagent consumable-driven revenue base, which is 75% of segment sales, to be indicative of lasting recurring sales that contribute to the firm’s moat.

One of its major product segments is immunohematology, where Bio-Rad offers a full product line for blood banks and transfusion labs. We believe Bio-Rad has been able to maintain a top-three market position through niche specialization and by offering one-stop shopping for blood bank and transfusion customers. We believe switching costs are the dominant moat source in this unit, due to the closed-loop razor-and-blade model for its equipment and consumables sales. Additionally, we think its strong market positioning and clients’ familiarity with Bio-Rad’s test systems supports ongoing incumbency.

Another product that contributes to its economic moat is Bio-Rad’s D-100 system for diabetic testing, a niche where the company holds market leadership. Diabetes is one of the firm’s fastest-growing markets in diagnostics, with market growth of 6%-8% compared with mid-single-digit growth in other diagnostic areas.

This segment also sells diagnostic quality controls, which are control tests run on diagnostic instruments made by the largest diagnostic manufacturers, such as Roche and Abbott. We do not think this is a moatworthy business, as there are few barriers to entry (vendors simply need to prove their control tests are effective) and test differentiation can be limited.

In life sciences (about 40% of sales), Bio-Rad sells various life sciences tools used by research labs, biopharmaceutical manufacturers, and food testers. Example products include western blot machines used to separate and identify proteins in the lab, chromatography products used for purifying proteins during bioproduction, and digital polymerase chain reaction tools used to identify and analyze genetic material. We think Bio-Rad has some traces of intangible assets tied to its differentiated droplet-based dPCR platform and associated switching costs from consumables. However, we do not think they currently are strong enough to support a moat for this segment. Unlike clinical diagnostics, which is primarily a consumables business (at 75% of sales), Bio-Rad’s life sciences division is more equipment-driven, with equipment and consumables each accounting for roughly 50% of sales. In our view, the even split of equipment and consumables suggests that there is not a meaningful razor-and-blade model, along with the reliance on lower-margin equipment, which is likely to face higher market competition in the next few years.

One of Bio-Rad’s key strengths in life sciences is dPCR, a form of cutting-edge PCR that enables greater sensitivity, precision, and quantification compared with traditional PCR methods. Its ability to detect rare events and minute signals has applications in niche areas, including single-cell analysis, translational research, cell and gene therapies, liquid biopsy diagnostics, and others. Although Bio-Rad has strong market positioning in this emerging technology, we do not think its strength here represents a lasting economic moat, as current PCR methods are often effective enough to meet customer needs. Although this market could become more significant as more applications of dPCR are established, we are hesitant to ascribe a moat to this business for now.

The segment also contains other less material business lines, such as chromatography, western blot protein analysis, and protein sample preparation. On balance, the lack of moat in dPCR and relatively low returns of the business, with operating margin under 15%, suggests that Bio-Rad does not have an economic moat in life sciences.

We think the stake in wide-moat Sartorius contributes to Bio-Rad’s moat. Although Bio-Rad does not have a controlling stake, Sartorius accounts for approximately 40% of Bio-Rad’s fair value in our model and is highly material to the company’s share price and valuation.

Sartorius is a bioprocessing and life sciences supplier that specializes in single-use technology for biologics manufacturing. We think its business has attractive long-term prospects driven by continued adoption of biologics therapies in the clinic, including antibody drugs and cell and gene therapies. Sartorius’ wide moat is backed by its strong reputation for quality and extraordinarily high switching costs, which arise from the highly regulated and mission-critical nature of biologics manufacturing. Its equipment and consumables sales also benefit from the razor-and-blade business model. The majority of Sartorius shares are held by a family trust that expires in 2028. We expect no significant changes to Bio-Rad’s holding for at least the next few years.

Bio-Rad is a leader in niche areas including quality controls, antigens, and digital PCR, and it has a strong razor-and-blade model in clinical diagnostics.

The noncontrolling stake in Sartorius gives Bio-Rad material economic exposure to the bioprocessing market, a highly regulated industry with attractive long-term secular growth trends.

Although one-off items have affected results in the recent past, such as a restructuring that began in 2017 and a cyberattack in 2019, the firm has since then made progress on improving its operating profitability.

Bio-Rad’s life science business currently faces a challenging environment due to funding cuts for US life sciences research and the potential for a weakening biotech funding environment.

Bio-Rad has historically not operated as efficiently as peers, although it has made progress in ameliorating this concern in recent years.

The clinical diagnostics business is facing headwinds due to conflict in the Middle East.