Thermo Fisher Scientific

Thermo Fisher Scientific delivered solid second-quarter results. Sales were up 5% organically while adjusted operating margin improved by 90 basis points year over year, in line with our forecasts. Shares were up 10% in early July 23 trading after beating FactSet consensus estimates.

Why it matters: While the laboratory products and biopharma services segment continued posting solid organic growth, supporting the recurring revenue base, we are encouraged by analytical instruments' 7% organic growth and 4.2% operating margin expansion, pointing to a healthier capital spending environment for customers. We are pleased to see continued evidence that the PPI Business System is driving cost efficiencies and productivity gains, providing further margin support in line with our forecasts. While Europe and Asia-Pacific delivered high-single-digit sales growth, North America and China remained constrained, growing only at low-single-digit rates.

The bottom line: We maintain our $560 fair value estimate for wide-moat Thermo Fisher Scientific. Shares currently screen as fairly valued. We make no changes to our assumptions, as our model already reflects the midpoint of management's updated sales guidance (7% top-line growth), while our adjusted earnings per share forecast remains within the revised guidance range. We view these results as a positive read-across for the industry. Thermo Fisher's analytical instruments segment returned to 7% organic growth, pointing to an improving investment cycle. It is running ahead of peers Danaher and Sartorius; the latter reported only 2% equipment growth while noting that demand is stabilizing.

Coming up: The company raised full-year guidance to 6%-8% reported sales growth, with organic growth now expected at the upper end of its prior 3%-4% range. EPS growth guidance increased to 9%-11% (up $0.25). The outlook accounts for the microbiology business divestiture.

We are lowering our fair value estimate to $560 from $630 per share, as we see demand recovery pushed back further. We anticipate the current constrained environment to remain in 2026, but slowly return to historical mid-single-digit growth in the following year.

Thermo Fisher is a rare example of a company that has delivered its best years ever in arguably one of the worst years economically in history. In a normalized environment, we forecast Thermo Fisher's sales will increase approximately 5%-6% per year organically, boosted by the faster-growing CRO segment and wallet share gains. We expect the analytical instruments and life sciences segments to drive future growth, while the mature catalog business will provide cash flows to fund investments in growth areas, such as clinical trials (PPD). We anticipate Thermo Fisher's adjusted operating margin will steadily improve over the next five years. The company's improved product mix, internal sourcing efforts, manufacturing shift to lower-cost regions, and efficiency improvements should more than offset pricing pressure in many of its commodity products.

We forecast Thermo Fisher to continue spending materially on bolt-on acquisitions. The company's historical capital allocation strategy has favored acquisitions, and while we don't forecast any material deals, we expect approximately 100 basis points of top-line benefit coming inorganically. We use a 8% cost of capital in our assumptions.

Thermo Fisher has a wide economic moat, continuously supported by its ongoing acquisition strategy. The company is an aggressive and desirable acquisition partner, as only a handful of other life science firms have the balance sheet to support comparable large deals. Since 2010, the firm has spent an average of $4.7 billion per year on acquisitions, and we expect this trend to continue. However, with the total company size now dwarfing its peers, there are only a very few scenarios probable of an acquisition large enough to make a material dent in ROICs.

Strategically, the firm's acquisitions have been an enormous boon for its competitive positioning. There are only limited product gaps now in the company's offering to the life science research sector, which in turn has allowed it to steadily gain wallet share (average organic growth of 4%-5% versus industry growth of approximately 3% over the past decade). The one-stop shop approach, made possible in part by acquisitions, affords it pricing flexibility and results in strong customer relationships. The company finds a receptive audience with large pharma clients, which see sizable benefits in the simplified procurement process Thermo Fisher offers. As a result, the firm's penetration and entrenchment within the pharma end market (switching costs) are expanding, which we expect to continue.

The company has long been a ubiquitous name in the life science supplies, going back to the days of Fisher catalog. The company's access to customer channels is unparalleled; the legacy Fisher (virtual) catalog still dominates the marketplace, and its next-largest competitors in the laboratory consumables segment are materially smaller. Thermo Fisher's salesforce is by far the largest in the industry, and its distribution network gives the firm unmatched reach and scale. To get a better sense of the omnipresence of the life science supplies business, the company's revenue (excluding analytical instruments and diagnostics businesses) is nearly equal to the next three largest life science suppliers combined; its products reach nearly twice as many customers as competitors and its salesforce in this segment is four times its largest peer. The company utilizes its reach effectively; every business it has acquired has been fully integrated in its core operations and typically growth from the acquired businesses accelerates once the initial integration stage is complete.

The argument for the Analytical business moat is similar to the wide moat argument for its key competitors here Agilent and Waters. This segment serves a slightly less life science-tilted customer base than its other segments, but it benefits from switching costs and intangible assets. The intangible asset is the firm's differentiated technology and its leadership positions within tools such as mass spectrometry, chromatography, microscopy and others. Instrumentation is a high-ticket item, and typically comes with a recurring revenue stream attached. The business is also rather sticky, particularly within the biopharma end market, where the regulatory process assures high switching costs. Production methods have to stay uniform throughout the life cycle of a drug, which often extends beyond the life cycle of a typical mass spectrometer. Any changes to the production method automatically triggers approval from a regulator, which isn’t common. The market share among the big three in instrumentation hasn't materially changed over the past few decades, suggesting rational competition. Outside biopharma, switching costs aren’t as strong and are mainly a factor of interoperability (a typical customer acquires multiple tools from the same vendor) and to a lesser degree customer inertia driven by the accustomed-to expectations of a high-quality product portfolio.

Thermo's contract research operations is typically viewed by us as a narrow-moat business, but within Thermo Fisher it adds to the spectrum of research services provided for biopharma clients, further entrenching its customer base. Previously, this was the only missing meaningful offering, but by acquiring PPD, the company offers its clients even greater incentive to consolidate their activities with just one vendor.

The company is also gradually becoming less and less sensitive to economic cycles, as more of its revenue is tied to the "lights on" activities of research laboratories rather than capital budgets. The business mix has gradually shifted to consumables and services, large portion of which are recurring, and now constitute 82% of total sales. A shift toward biopharma clients has also made the company less susceptible to more volatile infrastructure and applied end markets, even in emerging-market geographies where the biopharma channel is experiencing particularly high growth.

Thermo Fisher is among the industry's best when it comes to cost control. As near-term spending is constrained, the company's margins show exceptional resilience.

PPD business has been growing at above-market rates, implying share gains. The company's scale and reach have boosted performance in this already-attractive business.

Thermo Fisher is raising prices in its portfolio, offsetting inflation and tariff pressures.

Tariffs introduce uncertainty for the entire life science industry.

China is still almost 8% of the company's revenue. We're increasingly concerned that current weakness is resulting in structural changes to this market, and Western companies are less likely to benefit from the eventual recovery in this market.

Thermo Fisher's academic and government channel remains soft, as the current US administration is taking a more stringent approach to grants.