Friday, December 21, 2012

Agilent Has Too Many Negative End Markets Right Now

I think that Agilent (NYSE: A) is a great barometer of a cyclical companies willingness to undergo capital expenditures. If companies are expanding CapEx then they will need to invest in test and measurement instrumentation. With this in mind Agilent’s recent results and commentary were not exactly encouraging. I want to break them down and see the areas of relative strengths/weaknesses with reference to Agilent’s and other companies’ prospects.

It’s Tough Out There

When a cyclically exposed company comes out and forecasts next year’s growth to be flat with EPS down 5% (at the mid-point) then you know times are hard. Recall that these numbers are nominal so they imply falling real growth. Perhaps Agilent is being too pessimistic here but, in my experience, companies with this type of broad based industry exposure are rarely behind the curve when it comes to the economy.

In fact I have rarely heard a company be so focused on the macro conditions on a conference call. If it isn’t the fiscal cliff, its European difficulties or delays in Chinese stimulus spending that are causing its customers to be canceling or delaying spending plans. The guidance wasn’t good, but it also included some discussion of a muddling economy in the first half followed by stronger conditions in the second half.  In response to a tougher environment Agilent is doing the right things and focusing on generating cost efficiencies by closing sites and selectively choosing areas of investment.

Which End Markets are Working?

Firstly, here is how its main segments are performing in revenue terms.

It doesn’t look good, but within this broad weakness there are some pockets of strength. Within EMG, communication markets were described as being down high-single digits within aerospace and defense was down low single digits. Industrial, Comps and Semiconductors were as weak as can be expected with the ongoing downgrades to growth being made by Intel (NASDAQ: INTC) and others.  Of course, the reason Intel is guiding lower is because its end market customers (mainly consumer electronics companies) are finding it harder to shift inventory and this should feed through into general market weakness for a company like Agilent which relies on these companies investment plans.

The one bright spot in EMG was wireless spending which was a bit soft in the quarter, but this is seen as being due to a natural pause from previously strongly growing quarters rather than any kind of problem with carriers’ wireless spending. I think there is cause of optimism here because these comments mirror what Cisco (NASDAQ: CSCO) said recently about wireless spending. I’ve discussed Cisco’s results in an article linked here. However Cisco also mentioned that it saw some signs of improvement with overall US service provider spending. This was not confirmed by Agilent.

Going forward the concern with wireless is that competitors like Teradyne (NYSE: TER) are chasing its obvious growth prospects. Indeed Teradyne recently agreed to buy private held LitePoint which is a leading player in the wireless testing market. It’s hard not to envisage that competition from Teradyne and others won’t start pressuring margins in future.

Chemical analysis orders were flat with revenues down 3% with softness all round except for drug testing. Food maybe doing okay, but it only makes up 5% of end revenues with chemical & energy makes up 13%. Agilent is a very cyclically exposed company.

It is a tale of two end drivers within the Life Science Group. Austerity measures are causing a slowdown in funding for academic research but pharmaceuticals appear to be continuing to spend. The strength in the latter is a point that I think a lot of investors miss. Forget about the fiscal cliff, big pharma has been battling the patent cliff in recent years. Either it invests in R&D for a healthy pipeline or it faces steadily declining revenues.

I like to compare what Agilent reports within this segment to a company like Bruker Corp (NASDAQ: BRKR). Bruker has displayed some surprising strength this year most notably because it has exposure to academic spending in its end markets. No matter it has outperformed thanks to product innovation and timely releases compounded with strength in optical imaging.

Where Next for Agilent?

As ever with cyclical companies, price movements will largely be dictated by a kind of moving weighing machine over prospects for the global economy. The good news is the management doesn't appear to be baking in overly positive assumptions.  This probably leaves the company exposed to the upside if the economy does create some positive surprise going in 2013.

As to its own execution I don’t think that wireless and pharma spending is enough to justify an investment here. Agilent has too many end markets exposed to areas of the economy that are notably weak right now and the near term outlook is getting worse. 

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