Wednesday, November 7, 2012

Agilent Earnings Analysis

It’s always useful to get an industry read across from a company that services many different end markets. In this article I will focus on Agilent Technologies Inc (NYSE: A). It is a cyclical stock and has suffered over the summer as global growth has turned out weaker than expected. However within its end markets there are some varied trends of which investors can either avoid or take advantage.

Agilent Technologies

Agilent is a test and measurement company so when global growth is good and companies are engaging in capital expenditures we can expect Agilent to benefit. Obviously this makes its earnings highly cyclical. A quick look at its revenue share by business segment.

Clearly Agilent’s prospects are largely dependent upon the key Electronic Measurement Segment and I will get into more granular detail in a moment. For now let’s look at how future prospects are looking.

Here is a chart of orders by business segment.

The electronic measurement business is doing ok and the life sciences segment is holding up well but we are seeing declines in new orders in chemical analysis. It’s time to look in more detail into the underlying trends.

Electronic Measurement

The key end markets here are communications (21% of total revenues), aerospace & defense (8%) and the industrial, computers and semiconductors division (20%).

Despite the headline data looking stable, the underlying picture is mixed. Somewhat surprisingly in the last quarter aerospace and defense revenue was down 11% and I can only conclude that this division is heavily skewed towards defense spending. While US Government spending was described as stable, defense contractor spending was described as weak.

Turning to the industrials/computers/semiconductors division I have some concerns here. Results were down 4% but semiconductor and computer revenue growth was described as ‘solid’ while industrial demand was cited as dropping. This is worrying because Intel (NASDAQ: INTC) recently updated the market and downgraded its full year revenue expectations. More importantly it guided towards the lower end of capital expenditures for the year and this sort of slowdown will show up in Agilent’s numbers going forward. Intel is relying on the Windows 8 upgrade cycle but few computer manufacturers are reporting good news here.

I’ve saved the best news for last. Communications revenues were up 7% amidst strong demand for wireless manufacturing and testing driven by smart phone adoption. This is secular growth trend and looking at what AT&T and Verizon are saying about spending there is a clear shift towards wireless spending from wire line.

One company worth looking at in this regard is Ixia (NASDAQ: XXIA) which is a leader in communications testing. Ixia’s prospects are determined by carrier spending but they are skewed towards test measurement in 3G/4G/LTE spending. So whether its data center spending (very strong this year) wireless or even less developed countries rolling out 3G, the company has good prospects. I think its long term prospects are excellent but I would urge some caution here as its fierce UK rival Spirent issued notice that its end markets are slowing. Ixia’s share price is extremely volatile and it is doing very well now so I would look out for the next news flow before chasing the stock higher.

Chemical Analysis Group

This is the hardest hit segment and Agilent is quite clear that it is a macro issue rather than a competitive one. Chemical & Energy (13%) was described as flat and it is being affected by lower replacement business in the private sector. A clear sign of a cyclical slowdown. Emerging markets are helping growth via long term infrastructure projects but it is not enough to make orders positive overall. One concern is how weak Environmental & Forensics (10%) are at the moment. I take this as an indication that Governmental spending on the environment is not as protected as many think it is. The one bright spot was Food (5%) which rose 3% largely driven by emerging markets.

These results don’t read across well for key competitors in this segment Thermo Fisher (NYSE: TMO) and PerkinElmer. A quick look at TMO’s recent outlook shows that it nicely mirrors what Agilent is saying. Its management talked of academic and government spending being down low single digits, but there is ongoing strength in pharma and biotech spending. Meanwhile healthcare and diagnostics spending remains strong while TMO is somehow managing to wring growth out of its industrial and applied end markets.

The difference between TMO and Agilent is that the former has a lot more of its revenues in the faster growing sectors of its end markets. It is a much more cyclical company.

Life Sciences (including Diagnostics and Genomics)

The last segment to look at also has mixed results. Pharma & Biotech (13%) remains strong and was up 4% driven by technological changes which are spurring secular growth. The downside comes from Academic & Government (7%) which was down 6% largely as a consequence of reduced public spending. Meanwhile diagnostics (3%) growth was primarily generated by Dako.

Pharma & Biotech is an obvious source of strength and investors should look for more portfolio exposure here.

Turning to academic spending, this sort of weakness might worry investors in a company like Bruker Corporation (NASDAQ: BRKR). That said Bruker reported a very respectable 10.4% organic revenue growth in the last quarter although it mentioned some weakness towards the end of the quarter. Moreover whenever a company talks about having been ‘somewhat immune’ to the European situation over the last year I start to worry that the reported weakness from the end of May could in fact accelerate. Throw in Bruker’s exposure to industrial & applied markets as well as semiconductors and the outlook seems pretty similar to Agilent’s.