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

Good morning. Dan Brennan here. One of the 3 life science tools analysts from Cowen. Really pleased to be kicking off the 42nd Annual Account Healthcare Conference virtually, unfortunately, but hopefully next year back in person. And with us on the virtual stage here is Michael Stubblefield, President and CEO of Avantor. Super pleased to have Michael with us, Michael, welcome.

Yes. Thank you, Dan. Happy to be here. I guess this conference kind of marks the couple of year anniversary of the pandemic as it were.

Exactly. We're hoping to sneak it in live, but I think we made the prudent decision here. So I've got a series of questions. Folks can kind of shoot me an e-mail through, I think, the webcast link and e-mail, and I will certainly try to get to them, but we have a long list here. So if I don't get there, apologies.

So Michael, maybe just kind of a couple of high-level questions to kick it off, we have half an hour. The company is coming up on 3 years of being public, execution has been solid, and the company is now embarking on more M&A. For investors evaluating the Avantor story, how would you describe the key tenets of the investment thesis, what are the biggest opportunities looking out for the investment story to improve even further?

Yes. I think that's a great place to start, Dan. We're obviously very excited about the positioning in the business that we have here. I think it starts with the large addressable market that we serve that's driven by our exposure to the biopharma space where more than 50% of our revenue comes from. I think we have a favorable mixed dynamic here that will continue to drive strong growth and margin expansion as we continue to increase the capacity to address the robust demand that we're experiencing. We have an unbelievable free cash flow model that has enabled rapid deleveraging over the last number of years and really put us in a position in 2021 to deploy over $4 billion of capital towards M&A, bringing in in-house here, important technologies and really increasing the amount of proprietary content that we offer that ultimately leads to accretive growth and stronger EBITDA margins over time. And then I think perhaps most importantly here is where you led with, which is the business has an incredible track record of execution with both outstanding financial and operational performance over the last number of years, including in a pretty challenging environment here over the last couple of years.

Excellent. So maybe another big picture one here. The guidance through 2025 that you laid out is, I think, I believe 4% to 6% organic top line. When you look at your '22 guide, it assumes 7% to 9% ex COVID, and that's against a difficult comp as well. So what are the key factors that underpin kind of that 4% to 6%? And what are the prospects of even a faster level of growth that could be sustainable through 2025?

Yes. So I think one of the things we're excited about is even in the face of a couple of hundred basis points of COVID headwinds, we're in a position to affirm our long-term growth guidance of mid-single digits for our business this year. We'll be able to realize outsized impacts from pricing this year, primarily as a means to offset the inflation that we're seeing and that will ultimately have the impact of protecting the core business and addressing the headwinds that we'll see from things like PPE and testing coming down this year as hopefully, we move towards more of an endemic state here within COVID. But we would obviously assume in here stable end markets, again, driven by strength in biopharma, particularly bioproduction where we have an order book that's as robust as we've ever seen, nearly a full year's worth of revenue, and we're taking orders every day. I think to be at the high end of the range or even outside the range that we've described here, I think you'd look to continue momentum in biopharma for that, perhaps additional pricing opportunities throughout the year as those materialize. And then I think stability from a COVID standpoint would be important to push us outside there. But we'll continue to realize growth from monoclonals, cell and gene therapy, mRNA activities that potentially could accelerate over time. But we're excited about the exposure we have to biopharma, obviously, and being able to bring an integrated solution to the market with now more than 40% of our revenues in biopharma coming from our production solution, and we're well positioned to continue to benefit from the tailwinds in that space.

Great. So kind of pricing, the company has been constructive about the ability to pass through price increases to offset inflationary pressure. I think you've characterized the environment as hyperinflationary. Obviously, we see what's going on with oil. So I think historically, you said pricing is about 1/3 of your growth, so call it 1.5% to 2%. And in 2022, I believe, you're baking in double that level. So maybe 3% or 4% even. So a few questions. As the math sound right, what areas you're able to achieve that pricing leverage in? And finally, is there a need to even possibly look to go higher given where commodity prices are today?

Yes, I think your math is about right. We've anticipated roughly a 2x impact this year from pricing from what we would see in a more normalized environment. And that may prove to be conservative. In fact, when we look at what's going on here, oil now about $115 to $120 a barrel, certainly will have an impact on logistics costs and other input costs, which is very likely going to cause a need for ongoing pricing actions. Certainly, it's going to be dynamic. We've been successful with the increases that we put through in the market today to offset the cost environment we're currently facing, but we'll continue to monitor this. And fortunately, we have the tools, the processes and the capabilities to be able to react pretty dynamically to the situation as it unfolds throughout the year. But in some ways, it probably feels like that 2x that we've got baked in here could prove to be a bit conservative. And we've driven pricing across our business. We haven't had run into any really structural issues in any of the end markets that we serve. And I think that's one of the important characteristics about our business here is just the ability to push price as needed in an environment like this. So I think we -- as we look at both our growth outlook as well as our prospects for margin expansion of more than 125 basis points this year, I think we remain quite confident in our ability to deliver on both of those.

Great. And then related to kind of customer activity and feedback in the wake of what's happening with Russia and Ukraine. To what extent does this terrible situation create risk to the demand picture in say, 1Q or 2022? Can you also speak to what your direct exposure is in the region?

Yes. It's a tough situation. And I think, firstly, it's probably important to acknowledge the tragedy that is unfolding there. And certainly, our support is with all those who are affected by the conflict. And consistent with our values and our mission, we would certainly strongly condemn the violence that we see playing out here. Both Russia and Ukraine for us are quite modest, I think , less than $5 million, $6 million of revenue in total. We don't have any assets or direct associates in either country. And so at least as the conflict is contained to those 2 countries today would have -- has had limited to no impact on our overall business. From a COVID standpoint, we haven't had any exposure to the Sputnik vaccine, our exposure is going to be tied into the major viral vector and mRNA and recombinant vaccines and therapies that would be produced here in Europe and in the U.S. So as we look at it today from a customer and demand standpoint, any impact is certainly on the fringe, certainly manageable. And we'll continue to be active in monitoring the situation to see how it evolves. But at least from a demand standpoint, as we sit here today, no impact as of now.

Great. Well, let's maybe toggle over to some of your customers in pharma, obviously, being the biggest and kind of the biggest driver. So we're going to start there and spend a fair amount of time there. Maybe just to kind of kick it off before we dig into bioproduction, I know the topic of funding has come up. We wrote about it a few weeks ago. Some CROs have talked about it, and 1 or 2 small tools companies have talked about biopharma funding. Just what's kind of maybe your exposure to this emerging biopharma space? And is this something with capital markets being roughly -- collectively closed right now. Is this something that should be concerned despite, I believe all the money that's been raised over the last couple of years still affords them with a strong balance sheet. Is the trajectory of funding slowing? Is that a problem? Or is that a risk for Avantor?

Yes. Great question. I appreciate the opportunity to address something that, at least in our view, we see as quite overblown at the moment. We're aware of the 1 or 2 data points that have been reported. But I think were we're in line with most of the larger players in this space that have not seen any impact one way or another from any potential change in funding. We're out of the gate strong in our business, both in the R&D environment as well as in the production environment are both performing in line with our plan. The space has benefited from an uptick in funding from a lot of different sources, not just the capital markets, but the government funding as well as the multiple sources of private money, and there continues to be a pretty significant pool of capital that's being directed into this space. And I think one of the things that's important to keep in mind, as we sit here today, there's double, if not close to triple the number of modalities to invest in now as cell and gene therapy have really emerged strongly and you now have mRNA, not just as a COVID-vaccine, but as a bioengineered vaccine platform, broadly speaking, as well as a stand-alone platform for many other indications that hold a lot of promise. So we're excited about the backdrop and have not had any impact to date. The biotech customers are an important customer segment. There's a lot of development and science being driven there. We have great access to these customers through a number of different channels. And were -- all those customers in agri are performing well in line with our plan here. So a little bit hard to kind of unpack some of the concern that we do see there, just given what we see in our own business too.

Great. Okay. Well, I want to dig into bioproduction, your competitive positioning, kind of opportunities for share gains. So -- and then we'll dig into some of the outlook, the backlog in terms of how COVID and non-COVID are kind of playing out, particularly on the COVID side where we get some questions there. So maybe just the first one would just be, from a high level, when you think about biologic drug production and your buffer and excipients business, just kind of give us a sense of your -- I know you're a leader there. Like what's the relative share across that area for you? And kind of what enables you to have such a strong share and anything about the competitive environment?

Yes. I think one of the things that is important to understand about our portfolio is we are going to be the leading materials provider into the bioproduction space. And we're going to have content, whether that be process ingredients and additives into cell culture formulations or chromatography, buffer solutions, ultra-high purity chemicals for viral clearance activities or excipients that become part of the final formulation that's injected into the patient, we're going to have a pretty comprehensive chemicals offering across the space that's complemented by our single-use portfolio that continues to grow in capability, particularly on the back-end of the acquisition. When we look at our positioning in each of these areas, we would find ourselves as a leader in most of everything that we do here. And maybe the most exciting part about that is we're a leader in most of those areas with probably anywhere from, call it, 15% to 30% share, depending on the material, which speaks to the fragmented nature of the space that we play in, which gives us a lot of headroom for ongoing organic growth. And of course, it also then lays the groundwork for a pretty rich M&A pipeline that we'll continue to work over time. So structurally, we're extremely well positioned here with a very comprehensive end-to-end offering that we'll continue to invest in, both from an R&D standpoint capacity as well as to continue to grow our position through deploying capital.

So maybe on the single-use side, which you mentioned, and I know the company has been talking about this. Just kind of give us a flavor for what specifically like broadly is in your single-use offerings, kind of any sizing of that business within the broader bioproduction and really kind of what differentiates you, particularly in that space? Because it sounds like that's an important growth driver, one that's also very profitable for the company.

It is. It's probably the fastest-growing part of the platform, growing well in excess of 20%, and we don't see that slowing down anytime soon. We've been very aggressive with our investments in this business to scale capacity. We've scaled virtually every one of our facilities last year. We put on the ground a new facility in Europe. We obviously acquired a site in China. So we have a very differentiated global footprint that then enables us to produce products as close to our customers as possible. From a solutions standpoint, we're super excited about having one, if not the only end-to-end aseptic fluid management solution in the industry, starting with the parastoltic pumps to drive the fluids through the process, a full complement of tubes, connectors, manifolds as well as both 2D and 3D single-use bags that are integrated into the offering. So we're going to be really integral to how any of the fluids are moved through these systems in a closed aseptic environment. And that's going to be both for things like raw materials as well as the transfer of all the fluids through the process, including the proteins and such. So we're going to be front to back with this solution. And one of the things that Masterflex did for us was it may not be so obvious, but one of the first technologies that's considered in the process design for a new production unit is going to be the process flow and the pumping technologies. And so Masterflex has enabled us to get a seat at the table even earlier in the workflow design than what we might have otherwise had access to. And all this just works to be complementary in that. Once you're at the table talking about one technology, you're obviously well positioned then to pull through the rest of your portfolio. And we've had some pretty exciting examples of that even in the first 4 months of owning that business.

And do you think the margins are sustainable in single use? I think they're significantly above the corporate average. Just how would you discuss the profitability outlook there?

Yes. So all of our proprietary technologies perform well above the corporate average and the single use part of the business is no different than that. We're well positioned here owning both the product and the process technologies here. And given the specification nature, the custom nature of what we do here, not only is it very sticky but the margins are quite sustainable as well.

Great. So let's talk about the outlook for '22 and maybe longer term in bioproduction. Let's start with COVID. Let's dig into that a bit because that's where we get a lot of questions. The guidance for '22 assumes $250 million of COVID revenues across testing of bioproduction. And for bioproduction specifically, we assume $200 million kind of flattish year-over-year and kind of a similar rate of kind of flat is expected from some of your larger peers. So what's kind of the visibility on that flat year-over-year, the expectation that vaccine volumes likely down in '22? So maybe can you just speak to the order book and trends for COVID? Could you separate or give us some flavor as well between vaccines and therapeutics?

Yes, exactly. I think first, maybe a little context is helpful here. We don't have nearly the level of exposure as many of our peers do to COVID. But I think in our guide, we're contemplating somewhere around 2% to 3% of our revenues coming from this area. So clearly not the driver of our performance in 2022. I think the shape of our exposure is in line with what you've described there, Dan. We've got a pretty good visibility into the order book, particularly on the vaccine and therapeutic side, less of an order book or less visibility into the PPE and testing. And of course, we're not expecting much from either of those areas this year in any event. Obviously, we're watching the vaccine trends play out kind of real time. I think there's a couple of things to watch here. One, there's still a pretty significant percentage of the population globally that has not had any vaccine yet and so that will be certainly a driver, the booster demand in Europe and the U.S. later this year will probably be something to watch. But whether it's flat, modestly up, modestly down, it's rounding in our model. And I think certainly within our guidance here, we've got room to absorb that kind of play around the average, if you will, as things unfold here. So while we continue to watch it closely, but it's not -- one way or another it's really going to drive our business this year.

Got it. And then when you think about beyond '22 and the capacity that you've built up to serve or to produce the products that go into that $200 million of revenues, beyond '22 where we think COVID declines, what's the right way to think about that revenue contribution as that declines? Does it get backfilled on top with the base business? Just kind of give us a flavor how to think about beyond '22, that kind of COVID-related business?

Yes. As we've said from the beginning, the COVID upside, if you call it that, probably wasn't one for one in that -- as we've had to prioritize COVID orders ahead of core orders, everything we've seen here probably hasn't been one-to-one accretive. And similarly, as things start to normalize and perhaps normalize at a lower level that will free up capacity to service the core business. And so you have -- that dynamic gets taken into account. From a capacity utilization standpoint, the fact that the core business is the overwhelming majority of what we do here, and the fact that, that part of the business minimally will grow teens plus, if not north of 20%, any excess capacity here that gets freed up through any downturn in vaccine demand will get soaked up in pretty short order here by just the growth core business. Most of the work that we do here to support these COVID vaccines and therapies is fungible and that it's also the same material and the same content that would go into a core therapeutic area. So quite fungible from that standpoint gives us a lot of flexibility as we transition away from the focus on COVID and back to the core.

Got it. And then kind of your base bioproduction business, as you mentioned, ex-COVID kind of growing around 20%. And as you mentioned, I believe mid-teens is the outlook for 2022, so very attractive. You talked about a super strong order book is kind of the mid-teens versus 20. I mean, I'm splitting hairs. Is that just conservatism? Is it lower of large numbers? Or just how do we think about whether 20 is the right number or 15 is the right number?

I think we're obviously early innings here in the new year and probably reflecting that there are still modest supply issues in various materials, and we've got capacity expansions that need to come online throughout the year. So probably splitting hairs to some extent, but just giving us a bit of room to reflect that environment. And as we've done in prior years, we're obviously driving for much more than that. And we have a market backdrop and an order book that would certainly support continued growth here.

And Michael, do you think is mid-teens what like the addressable market you're serving for your products growing at? Are you growing faster than the market? Are you taking share? Just kind of -- just give us a sense of maybe -- obviously, you've got significant share in the buffer and excipients to chemical business, single-use. I'm not sure like is that -- I assume there's a lot more penetration to go? Just give us a sense of that kind of mid-teens and how that compares to the markets you're serving?

Yes, if you go back over a long period of time, the analytic work that we have done and the triangulations that we've been able to put in place would confirm that we would historically on the chemical side of the portfolio outgrow the broader market by probably a couple of hundred basis points. And certainly, as we've seen an acceleration in growth over the last couple of years as these pipelines have accelerated and you've had an increased number of new products that get launched, we feel that trend is probably carried forward. Excitingly, we've really been able to invest aggressively in single-use capabilities and now see that part of the business growing well over 20% far beyond, I think, the broad bioproduction growth rates, which I think also gives us a view into share expansion over time. Now a lot of this is associated with new molecules that are getting launched, share gains and share movements on existing platforms, probably more of a theoretical discussion than reality. But we do know that given our global footprint, the comprehensive nature of our offering, consistent with the thesis of when we brought our business together with VWR, we know that we're working on more molecules we've ever worked on before. And we also know that we're putting more content on every molecule that's coming through the pipeline. And all of that leads to accelerated growth over time and share gains.

Great. We'll have several more questions on some of your end markets and product areas. But let's just jump forward in the interest of time we could circle back here in the final minutes. I wanted to ask about the balance sheet and margins, which are critical to the Avantor story. So free cash flow this year, you've guided for greater than $1 billion. We're slightly above that, about 101% of adjusted net income. Maybe first one, in terms of free cash flow conversion, looks really solid. Are you satisfied? Is there more -- are there other even more areas to improve there?

Yes, we've come a long way on free cash flow, obviously. It wasn't that long ago that we only had a couple of hundred million of free cash flow with modest conversion. And as you suggest, our present conversion is approaching 100%. We focus pretty diligently on working capital as a percentage of sales. And we've made strong progress here in recent years. And CapEx, obviously, is the other variable there. This is 1 of the advantages of our platform and that it's a capital-light model. We can grow our business sustainably by investing 1% to 2% of revenue in growth-related CapEx. We'll see a step up this year to plus or minus $150 million, well within the long-term algorithm there and provides us ample capacity to be able to grow the business. So when I look at where we're at, CapEx is very much in line with our expectations. Working capital will continue to be the focus and the variable here, but approaching 100% here, and we're pretty excited by the progress we've made.

And then you've done the Ritter deal, you did the Masterflex deal. If you have a moment, we'll touch upon those here. But just obviously, the market has been under a lot of pressure here for various reasons, obviously, Russia-Ukraine. But that affords folks with the balance sheet, looking to do deals, maybe more opportunities. So how would you characterize the deal pipeline today? And do you have any line of sight on bigger deals? And maybe just kind of what are the areas of focus that we should be thinking about in terms of M&A?

Yes. We've been consistent with our strategy here. Nothing has really changed from that standpoint. We're going to be focused on buying growth-oriented assets that bring proprietary content in areas like bioproduction, some of the high-growth workflows in the lab as well as in the clinical space from a services standpoint, really robust pipeline. We continue to be quite active. I don't think sellers' expectations have necessarily moderated or caught up to maybe some of the dynamics in the capital markets that have played out over the last couple of months, and we'll continue to be disciplined from that standpoint. But from a leverage standpoint, we start this year with roughly the same leverage as we had a year ago when we were able to deploy roughly $4 billion of capital. So we intentionally finance the Masterflex deal to preserve flexibility that if the right deal came across the desk here that we would not be constrained in our ability to execute on that. So we like the flexibility. We like our positioning in having multiple areas to invest in that would create value for our customers and for our shareholders, and we'll continue to be quite active this year in pushing that forward.

And then margins are a critical part of the Avantor investment thesis. This year, really robust margin expansion 125 basis points in longer term through '25, you've talked about $50 million to $100 million. So kind of a 2-part question, you had kind of the confidence in that $125 million, you touched upon it earlier in the conversation with the ability to continue to take price to offset inflation. So I'm just wondering the confidence level and then b, on the 50 to 100 kind of what gets you to the higher end of the range? And what kind of gets you to the lower end of the range? And kind of how do we think about that?

Yes. So I think just to hit the most important question here, which is our confidence in the $125 million. We're extremely confident. We're well into the pricing levers that needed to be pulled to offset inflation. We may need to do some incremental work here throughout the year, depending on how inflation tracks going forward. But we're in really good shape from protecting and growing our margins by managing that price over COGS relationship. The mix continues to be favorable and that our proprietary content continues to grow at accelerated rates, which drives that natural drift upwards in margins over time. And then, of course, this year, then we're going to get the outsized impact of the 3 deals that we did last year. And you see the benefits of that even in the fourth quarter, where we only had Masterflex for 2 of the 3 quarters -- or 2 to 3 months, excuse me, we still realized 140 basis points of margin expansion with those deals. So that's going to provide us a nice accelerator to margins this year and between what we'll do organically, what we'll do through M&A on the deals we've already closed, it's nice to see things moving in and around that 21% level, if not higher.

Great. Well, I think with that, Michael, we're out of time. So obviously, thank you very much for being here and being part of the Cowen conference, and I hope you have a great one and for everyone on the phone, thanks a lot.

Thank you, Dan. Appreciate it.

Okay.