Avantor, Inc. (AVTR) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us today on day 3 of our Healthcare Conference. I'm Tejas Savant, and I cover the life science tools and diagnostics sector here at Morgan Stanley. I'm delighted to have Avantor join us this morning. And representing the company are Michael Stubblefield, CEO; and Tom Szlosek, CFO. So welcome, gents. And before we get started, Michael, I have a quick disclaimer I need to run through. Please note that the webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. The webcast is not for members of the press. And if you are with the press, please disconnect and reach out separately. For important disclosures, please see morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales rep.

So with that, Michael, perhaps to set the stage this morning, can you just go over a history of the company, pre and post VWR? And from your perspective, how exactly has that value proposition evolved over the last 5 years or so?

Yes. Thanks for having us. Happy to be with you this morning. And I think that's a great place to start. With the Avantor that we have in place today, we've really brought together 2 companies in what we refer to as the legacy of Avantor and VWR, both with extremely rich legacies that each go back well more than 100 years. And in bringing these 2 businesses together, we've been able to combine a leading manufacturer in Avantor of ultra high-purity ingredients and materials with the leading customer channel to create a trusted global partner to customers in both the life sciences as well as the advanced technology industries. And our model enables us to credibly access more than 250,000 labs around the world. And with this access, we're able to position more than 6 million products and services to support our customers' research and the early phase discovery activities. And importantly, this access enables us to position our customized solutions that ultimately get specified into our customers' next-generation technology platforms, whether that be a life-saving therapy or a medical device. Being able to serve our customers' workflows on an integrated basis, from early phase discovery all the way through to delivery, creates tremendous value to our customers as they benefit from increased quality and efficiency and productivity. And we think that the new Avantor is uniquely positioned to serve the growing needs of laboratory and production customers around the world.

And then, Michael, now with the pandemic, has the role you play connecting this -- these thousands of suppliers to a highly fragmented customer base become even more critical? And if so, has that presented opportunities for you to gain sort of mind and market share with your customer base?

Yes. With our model, it all starts with the channel where we have tremendous scale and unparalleled customer access. That's as good as anyone out there. And the depth and the breadth that we bring that it's really critical for our customers. And our suppliers appreciate our ability to reach our customers on a global scale via our -- the reach that we get through our channel. And ultimately, our supply chain and our forward stocking centers provide customers with real-time rapid order fulfillment, which in today's environment creates a tremendous amount of value. And it's proven especially important, as you referenced, in the pandemic as we positioned our comprehensive workflow-based solutions for testing for PPE and certainly for vaccine development. And the strength of our channel has definitely enabled us to pick up some important new account wins, especially in the health care space, as our product breadth and supply chain security strengthen all of our customers' business continuity plans, which is so critical in a time like this.

Got it. And you spoke about 500 to 600 bps tailwind actually on the second quarter. That helped offset some of the headwinds you saw elsewhere in the portfolio. Can you just help us parse out these tailwinds a little bit? Which of these do you see as durable and which of these do you expect to wind down perhaps as testing or PPE demand like declines?

The tailwinds that we saw in the second quarter fell into 3 categories. Firstly, diagnostic testing, PPE and then our bioproduction business. Testing and PPE collectively represented about 3/4 of the tailwind that we saw in the quarter. Obviously, we're not exactly sure what those environments will look like in a post-vaccine period, but we'd certainly expect the favorable impact that we saw in the second quarter to continue in the short to medium term. The balance of the tailwind was driven by our bioproduction platform, where, as we talked a little bit about in the second quarter and certainly I've seen it continue into the third quarter, we have an unprecedented order book. And although we haven't seen the full impact yet of the vaccine, obviously, there's nothing approved yet. But we are participating broadly across -- all 4 of the major modalities are being explored. And our model will definitely scale quickly as vaccine candidates receive emergency use authorization. And certainly, we're looking forward to enabling those solutions.

Got it. And so just to put a finer point on that. I mean relative to the 500 or 600 bps you saw, do you expect the sort of total tailwind to be sort of at a similar level in the third and fourth quarter? Or do you think it could potentially be even higher as some of these vaccine candidates move into commercialization, perhaps late in or early next?

Yes. I mean in the -- we obviously haven't closed the books on the quarter yet, and then all the fine analytics that would get us to a specific number for tailwinds in the quarter. But in our second quarter call, we talked a little bit about July coming in kind of flat to low single-digit growth. Obviously, we now have the benefit of hindsight and can say that July came in at the high end of that range, and we've certainly seen that carry through the middle here of September. And that's going to be a combination of certainly some impact from the tailwinds. We haven't quantified the impact yet. But certainly, an improvement sequentially in our base business. There are elements of the business that we're certainly seeing headwinds in the second quarter, most notably in the academic and in the health care space. And we've seen meaningful improvements in both of those end markets as we've moved from the second quarter and into the third quarter here. And so through the combination of continued tailwinds and improvement in the base business, we're happy to see the business return to growth.

Got it. That's good to hear. And just in terms of some of those -- the weak spots in the portfolio at the moment. In terms of the month-over-month trajectories, is there anything that leaves you sort of like incrementally more concerned than you were at the time of your second quarter earnings call? Has everything gotten better? It just sort of improving a different sort of cadences.

I think in that call, we highlighted probably 3 major areas of impact. One was in the academic setting, where we saw the market bottom out, probably being off more than 50% or in around 50% to the month of April with incremental improvements through the quarter. And we have continued to see steady improvements in that end market as we've got into early days of September here. The health care space, which we play in somewhat of a unique way, about -- it's about 10% of our revenue, roughly half of that is a pretty novel exposure we have through our medical-grade silicone platform, and the other half is in more traditional health care. And the pullback in kind of "elective" procedures impacted both the medical implant side of our business as well as just in the traditional point of care, hospital clinic as I think unless you had COVID or thought you had COVID, but you probably weren't going to facilities. So we definitely saw significant headwinds in that part of the business. For both pieces of that, we've seen nice recovery here into the third quarter. I'm not sure the implant business is back to 100% yet. But on the other side of that business, on the health care piece, I think for the most part, we've seen improvement through the quarter and plus or minus, I would say, in a normalized demand environment there. And going back to my earlier questions about have we been able to increase share during this time? I think this is a good area where the strength of our supply chain has really enabled us to pick up some important account wins, and we're going to show some nice growth on the health care side of our business in the third quarter. The last area that we highlighted in the second quarter is being off a bit was some of our applied markets. It's about 1/4 of our revenue, and that's split kind of down the middle, about half of that is going to be somewhat cyclical in nature. The other half is going to be pretty insulated and pretty robust. And the piece that was more industrial in nature, obviously took a hit in the second quarter. That's going to follow the macro trends and the broad global macro fundamentals for the most part. So it's still off in the third quarter. But it's -- we have seen some sequential improvement. And I think if you look at the global PMI, for example, I think it's now over 50. So we're seeing improvements there. And you put all that together, and I think it paints a picture that the base business is now growing. I think we still got some room for incremental recovery moving into the fourth quarter, but a much better picture here in the third quarter than the second quarter.

Got it. Got it. And then obviously, is it fair to characterize biopharma just further along in the recovery relative to your academic lab customers? I mean that's the read we get from your peers, from our channel checks, but what are you seeing there? And is there anything that worries you in terms of perhaps a little bit of skepticism around CapEx spending?

Yes. So I would take a couple of things. One, the biopharma business for us, which is obviously a really important end market for us. It's about half of our revenue. And we would split that exposure, kind of -- 2/3 of that is going to be in the R&D space and the other 1/3 is going to be in the production space. The production piece of that has been a real strength for us throughout the year, and we've seen that accelerate in the second quarter and into the third quarter. On the R&D piece, there was definitely a bit of a pullback in the second quarter, but nowhere near the level that we saw the pullback in the academic space. And I think there's a lot of publicly available data that talked about the number of academic labs versus biopharma R&D labs that were offline. And there was a pretty big difference. And definitely, kind of as we have seen in the academic piece, more and more of the biopharma researchers have returned to the bench. And I think we see a nice sequential improvement here into the third quarter. That is an additional driver for our base business returning to growth. And I think we continue to be quite bullish about biopharma. We're bullish about it before COVID, and I think the pandemic has only heightened the focus on the importance of this biologic workflow. And it's also highlighted, I think, our relevance. The core biologics business, for the most part, is driven by monoclonal antibody modality. That the vaccine opportunity here, I think, has highlighted our relevance across all major biologic modalities and the transferability of our technologies across each of these areas. So I think there's pretty full pipeline of opportunities, both COVID related as well as non-COVID related that we think created a pretty robust backdrop for this business going forward.

Got it.

You mentioned about the CapEx environment and what impact would we get or see potentially from -- on our business from capital budgets going into the balance of this year. It's a great question because I think it highlights maybe some of the uniqueness of our business model, which we like a lot here. We've been able to talk a lot through this pandemic about the resiliency of our business model. It's a highly recurring revenue business model. More than 85% of our business is going to be recurring. So this topic of CapEx, while it can maybe impact your business, positive or negatively. On the fringe, it's less than 15% of our revenue. So that trend isn't one that's particularly important to the outlook for our business.

Got it. Got it. And then Michael, going back to your comments on biologics and some of the cell and gene therapy manufacturing upside that you guys participate in. Can you walk us through, a, I mean, how exactly have you positioned the company to participate in that? What are the next steps for you in terms of making sure you kind of like punch above your weight in capturing that upside as some of those customers ramp into commercial scale manufacturing, particularly within cell and gene therapy? And then what have bioprocessing order trends look like for you?

Yes. Those are all important drivers of our business. And just to reiterate, we remain very bullish on the outlook for the biologics space. Funding has been favorable, and there's a robust pipeline of new therapies that are being developed. And I think it's important to recognize that our broad solution, coupled with our deep customer access would have a specified into more than 80% of the commercialized biologics that are on the market today. And by extension, we're very well represented in the pipeline. I highlighted that not only are we relevant in the core monoclonal antibody workflows, but -- as well as the other major modalities. And we drive our presence in our growth. It's all underpinned by our investments in innovation to bring new products and solutions to the market, most notably or most recently, the launch of our Protein A product, I think, is a great example of that. We've also been aggressively scaling our infrastructure, significant investments over the last several years and even through the pandemic here to ensure that we have the right manufacturing capacity in place to keep pace with the growth opportunity that we do have. Specific to cell and gene therapy, we recently doubled the size of our flagship development center in New Jersey, specifically to position us to capture opportunities in the cell and gene therapy area. Particularly in the gene therapy area, our relevance in that space, I think, has really been highlighted in the work we're doing on the COVID vaccine, particularly the viral vector candidates. And I think it's an indication of the opportunity that we do see in this emerging gene therapy area. Interesting enough, these gene therapies have been extensively worked on and studied for years in the lab environment, and we've been an important partner in that space. The real challenge that I think is as an industry that we face is how do you scale these technologies from the lab to full-scale commercialization. And we, with our solutions, whether it be our single-use solutions or our ultra high-purity GMP ingredients, we play a really important role in partnering with our customers to work out the issues associated with that scale up. And so there's a few therapies that are obviously approved and on the market that we would be certainly a part of, and we see great opportunity going forward here. And I think if you take a step back, certainly, the pipeline has a lot of monoclonal antibodies in it that has fueled the growth over the last decade. We think that there's a robust pipeline of those modalities that will continue to fuel the growth. What's exciting for me, though, given that this is kind of the cornerstone of our business model, with something like cell and gene therapy, already starting to take shape, you can kind of see the makings of the next wave of growth here. That should spur the industry well into the future here. And then the last point I would make is, beyond our investments in technology, beyond our investments in infrastructure to make the capacity available, the next lever of the playbook here really now starting to come into focus through M&A. And as we have improved the health of our balance sheet. We're now on the cusp of kind of our target leverage range, which will allow us then to use M&A in a meaningful way to also supplement the capabilities that we have broadly in this biologics space to make us even a more valuable partner to our customers.