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

Healthcare Conference live in Las Vegas. I'm Derik De Bruin, the senior life sciences and diagnostics tools analyst for those of you who don't know me. And our next company is Avantor. And with us today is Michael Stubblefield, President and CEO of Avantor and a company that's come a long way since the IPO. We did gosh, it was like, what, 3 years ago?

Going upon our 3-year anniversary next week.

Time flies in the pandemic.

So I'm feeling generous this morning, so I'm going to give you an easy question to start. We -- when we hosted you at our fireside chat at our virtual conference last year, we were still doing a lot of education on the basic of Avantor story. It seems like now many investors are more familiar with the business. But is there anything that's sort of different about Avantor now versus when we talked about a year ago? What sort of like evolved to the company?

Derik, thanks for having us. Really great to be in person with you all, and I certainly appreciate the support. Our business model is grounded in an integrated discovery to delivery model where we're going to be relevant to our customers at virtually every stage of their journey from research to scale up to manufacturing. And we're going to do that with an extremely comprehensive portfolio and an unparalleled supply chain that allows us to provide really great service to our customers. When I think about the journey that we've been on and the progress that we've made since we were together virtually a year ago, I would say it's probably highlighted by the progress that we've made in executing our growth strategy. We've deployed more than $4 billion in capital to buy 3 assets that increased our proprietary content to more than 55% of our revenue and margins that are nearly double the group average. We made significant progress in our efforts to bring innovative solutions to our customers. We launched more than 125,000 new products, with many new products coming from our proprietary bioproduction and biomaterials offerings. And one of the things that the pandemic has afforded us is the opportunity to accelerate investments in capacity and infrastructure to support our long-term growth. We have more than 2 dozen expansion projects in flight as we speak, many more that were completed last year and many that were completed in the first quarter. That will really set us up well over an extended period of time to be able to continue to grow this business.

So there's a bunch that I want to unpack with that, but let's start on the underlying demand question. I think one of the things that sort of struck me, particularly coming out of the first quarter earnings season, was the numbers for the life sciences tools sector were really good. I mean -- and companies were selling a lot of analytical instruments, and I mean you're just sort of seeing 20% growth in LC-MS. I mean that just is not normal sort of for like this space. It's like -- so this sort of leads to the questions, it's like are investors -- I mean are your customers stocking, right? Are they buying because they're worried about rates going up? Are they a buyer because it's like this -- I mean, I know you don't have the analytical instrumentation exposure, but I mean the demand looks really good. Is there something -- is the overall -- is the underlying market just that good? Or is this the party before it gets rated?

We're certainly excited by the strength of all of our end markets. The first quarter, we obviously got off to a great start with more than 5% organic growth, and the fundamentals across all 4 of our core end markets were really strong. In our biopharma end market, which is more than 50% of our revenue, really strong momentum, both on the research side of that business and then with the number of new molecules that have been commercialized, the production business for us continues to grow, excluding COVID, more than 20%. In the education and government market, we have some headwinds from COVID that we face, particularly in the government sector, but we're encouraged by the sequential improvement in academia quarter-over-quarter, and it's getting close to being back to normal. Elective procedures and non-COVID-related diagnostics, I think, are pretty well back to pre-COVID levels. And given the unique exposure that we have to that health care market with the leading medical-grade silicone formulation platform where we're going to be spec-ed into most every medical device, implantable medical device, that's out there, that's an end market that we see some really good growth dynamics and where we have an order book similar to bioproduction that gives us visibility out to nearly a year now. And then in the applied markets, which for us is about 25% of our revenue, we have some custom proprietary solutions that we provide to applications like semiconductor manufacturing, which continue to grow double digits; the defense sector for us, again, proprietary space-grade silicone formulations that are -- continue to be robust and resilient. And there are a handful of application areas in there that tend to be more correlated to PMIs, which also continue to be robust. So around the world, our end markets remained strong in Q1, and we see that continuing even today. We were fortunate in that we have more than 1,500 Avantor-uniformed associates that work every day at our customers' sites. And in many cases, we are managing their inventories for them. And so we think we have a pretty good beat on order patterns and stocking levels and such. So the short answer to your question about do we see stocking and are we concerned about buying ahead of a pending cliff, it's not something that we're concerned about at this stage, Derik.

Great. And also just for, I mean, your China and Russia exposure is quite low, too just from a relative to the inflation phase.

On Russia for us is about $5 million of exposure. We don't have any assets or associates in Russia. We ceased sales into the country almost immediately and obviously expressed our concerns for what's going on there. From a China standpoint, it's a double-edged sword. We don't have much exposure today. Asia for us broadly is less than 5%, 6% of my revenue, and China is a subset of that. We're much bigger in India and Southeast Asia and Korea than we are in China today. So limited impact from what we see going down there from a lockdown perspective, but we're bullish on China, which is the other side of the coin. And it's a country that we continue to think will provide great growth opportunities for the biopharma franchise. And when I think about our investments to stimulate growth in an emerging economy like China or an emerging market like China, we're pretty well through our playbook there of localizing commercial capabilities, localizing technical capabilities. We opened up our innovation center in Shanghai just at the onset of the pandemic. And then lastly, having local manufacturing capabilities. That was ultimately the driver behind our acquisition of RIM Bio, and we'll continue to localize capabilities as that market evolves. But we see a lot of potential and a lot of promise in -- particularly in the biopharma area in China that we're excited about long term. Today, given the dynamics, fortunately, we don't have a lot of exposure.

So the -- one of the questions we keep getting from people is just on sort of like the state of the bioproduction and bioprocessing market. I mean it's obviously an important focus area for Avantor. I guess a couple of questions. It's like how are your -- how does your portfolio differ from that of, let's say, Thermo or Danaher does? I think this is a kickoff for that.

So you're right in that biopharma is the most important end-market for us. It's more than 50% of our revenue. And within that, more than 40% of our revenue comes from bioproduction, which has been growing more than 20%. So it's an area that we obviously spend a lot of time on and an area that we think will be an important growth driver for us over the long term, given the dynamics of the technology space and what's going on from strength in monoclonals, the emergence of cell and gene therapy in a very rich clinical pipeline there and given the experience we've all had around mRNA and through the pandemic and the acceleration to that pipeline. It's an area that we're quite bullish in. Our strategy to serve this area is, very clearly, we're trying to be the leading material supplier to this space. So when you look at my portfolio, it's processed ingredients that go into cell culture media formulations to drive increases in titer in a cell culture reactor. It's providing all of the buffers and ingredients that go into optimizing the separation processes in the chromatography resins. It's providing high-purity chemicals for viral clearance and viral deactivation steps. And it's being the leading excipient supplier to that fill finish step, which is so critical, given that those materials end up as part of what gets injected into the patient. So up and down the workflow, we're really trying to stake out our claim as being the leading materials provider to this space. And relative to the other players that might be focused on equipment or filtration or some other areas, we think this is a real niche for us where we've been a leader in for many decades. We have a global footprint, a global technology base and a global quality system importantly that has us well positioned there behind virtually every commercialized monoclonal antibody as well as all the emerging therapies in the other modalities. So we really like this business a lot, and we'll continue to invest in it.

So there's concern that as COVID therapeutics and vaccines wane, a lot of companies added capacity, that there's going to be this big gap in these companies' revenues as there is all this capacity but nothing to fill it. And so how is your order book? What are your lead times for that market? What's your visibility? And are you worried that the bottom is going to drop out of this market at some point in the near future?

It's a great question. When you look at the lead times for our materials that go into the bioproduction workflow, unfortunately, our lead times currently are probably 2 to 3x longer than they were pre-pandemic. And that's really just an artifact of the capacity constraints that the entire industry has felt given all of the additional demand that's come from COVID. But it is important, at least in our context, to keep it in perspective. COVID for us is less than 3% of our revenues today. And as we have given our outlook for the year, I think we've talked about a range of somewhere between $175 million to $250 million of COVID-related revenues in my numbers this year. So we're getting to the point now where, to the extent that it was somewhat binary and became 0 at some point, the growth that we're seeing in our other businesses outpaces what headwinds we might take on here. And our capacity is fungible, and this is a concept that you hear a lot of us talk about in this space. And in our case, it's something that we do actually every single day. So in my production facilities, whether it's a single-use assembly that I'm building or whether it's a excipient that's going into these formulations, my lines will switch back and forth multiple times a day, if not multiple times a week. And so this isn't a theory that's untested in terms of how fungible or interchangeable is this. This has been our life for the last couple of years as we try to juggle all of this demand in an environment where my portfolio is -- we're agnostic. Most of my technologies work across all of these modalities, and so it stands to reason that I'm trying to satisfy demand across monoclonals or vaccines and doing so all at the same time. So many of the investments that I'm making today, I've had to accelerate those in order to account for the demand that we're seeing from COVID and to help restore lead times. But most of these at this point are being driven by our view of long-term, sustained kind of mid-teens plus growth in bioproduction and wanting to make sure that I have the capacity coming online this year and next that puts me in a position to be able to restore more normal service levels. And in some of these assets, I referenced one in our recent earnings call at our 100-plus-year-old site in New Jersey, that asset probably won't come online until middle part of next year. And in many of these product categories, I don't -- our projections even in a bearish vaccine scenario, we don't see lead times getting restored until sometime next year. So it's going to be with us for a while. And we think given the magnitude that it is in our business today and the continued growth of the core business, we think that there's a nice transition that occurs here without much disruption whatsoever in our business.

So that's encouraging. I guess when you look at the -- when we look at the top line, so with that in context, right, and sort of like the -- some of the acquisitions that you've done recently and just looking at this, I mean your current organic revenue growth targets are something in the 4% to 6% range. You did -- I think you did 5-ish in the first quarter. Back half guide sort of implies -- and you're still looking at the same thing in Q2. Back half implies something around 5.5%, 6% exiting weighted to this. So when you sort of see your business exiting 2022 with sort of like the tailwinds from -- you still have from bioproductions and the new acquisitions coming in, I mean is the high end of that range or even better feasible for the out years?

When you look at the performance of the business over the last several years, I think we're running at a multiyear CAGR of 6-plus percent. So certainly, the business model has the firepower to grow sustainably at those levels. We like our end market exposure. And given our positioning within biopharma, the investments that we're making both organically as well as inorganically, that's becoming a more important part of our business. The general strategy for this business is to certainly move it beyond being a mid-single-digit grower to something that's higher than that credibly and sustainably. Our acquisition framework requires that the assets that we're bringing in are accretive to organic growth, and the 3 assets that we purchased last year certainly do that. Those will start to annualize into our organic numbers. Firstly, Ritter in the beginning of the third quarter. And by the end of the fourth quarter, we'll have all 3 of them into our organic numbers. And the more success we have in deploying capital will certainly create additional tailwinds to our organic outlook. So certainly, the focus of the team and the strategy is geared towards accelerating growth beyond kind of this 4% to 6% window that we've been operating in to something higher than that. And the track record of execution of the team, the fundamentals of the end markets, our positioning certainly would support your views there, Derik.

So you mentioned M&A. Well, actually, let me do pricing first. So what's embedded in terms of your model for this year for pricing? And can you talk about sort of how that paces through the year? There was a little bit of confusion in the first quarter. So just...

So our organic guide for the year is 4% to 6%. That's net of 200 to 300 basis points of COVID headwinds. So the underlying core growth outlook for the year is in that 6% to 9% window. Way to think about the mix of that or the breakdown of that, between pricing and volume is roughly 2/3 of that would be price, and roughly 1/3 of that would be volume. And that's a flip relative to our historical algorithm. In a normalized environment, it would typically be the opposite, 1/3 price, 2/3 volume. And we've obviously had to drive pricing harder to offset the inflation that we're taking on really across virtually every cost category that we do have. So this kind of 2/3:1/3 ratio that I just mentioned is kind of the outlook that we have embedded in that underlying 6% to 9% core outlook for the year.

And so how should we think about margin expansion? I mean you've got inflationary pressures this year. You've got FX, which given your big European exposure, which is a little bit outsized relative to your peers, is a headwind from that perspective. So how can we sort of think about the margin targets? And I guess are you comfortable with looking at the business going forward and sort of getting like 100 basis points of margin expansion in the future?

So we did 140 basis points expansion in Q1. Your point about FX doesn't really impact us at the margin line. That's more of a revenue impact for us just given our currency exposures to both cost and revenues around the world. It has really a negligible impact when you get all the way down to the margin line. So we have kind of a natural hedge built in there. Our full year outlook is to do something greater than 125 basis points. We're obviously ahead of the game out of the gates here. And we would envision that coming kind of equally maybe 50 to 75 basis points each from organic margin expansion as well as the contribution from M&A. The contribution from M&A is clear. We're pretty transparent or tried to be transparent in our earnings release here around the margins that we're seeing from the 3 deals that we did last year, and you see that they're approaching 40% EBITDA. So that's pretty straightforward. On the organic side, we were really excited even in this inflationary environment to be able to see even core margin expansion in this environment. I think we delivered roughly 40 basis points of expansion in Q1 really on the back of kind of managing this price COGS relationship, the dynamics of our proprietary portfolio growing at roughly 2 to 3x the rate of our third-party portfolio, and then we get really great operational leverage. As our business grows, those incremental revenues flow through at a disproportionate margin. So we have a high degree of conviction around our long-term organic margin expansion of 50 to 100 basis points. So if I take aside the contribution from M&A. and when we look ahead at 2025 with the businesses that I have in hand today, we're obviously excited to -- we're approaching 22% EBITDA margins. As we sit here today, our outlook for 2025 is to be north of 24%. And that really is just built on a continued organic expansion of 50 to 100 basis points driven by the factors that I just mentioned.

So can we talk a little bit about more of the proprietary product mix shift and the M&A sort of driving that? I mean you did do 3 acquisitions last year, obviously, accretive to growth in margins, the growth of that. COVID did roll off on some of those a little bit faster than expected, so there's some of the controversy in terms of some of the revenue contributions. And obviously, with Ritter, the euro sort of coming down sort of like changed that sort of math as well. But if you sort of like adjust for COVID, you adjust for FX, it's like what are those underlying acquisitions growing at?

We'll talk primarily about Masterflex and Ritter. RIM Bio was, relative to the other 2, quite minor. On the Masterflex side, which is the most recent acquisition. At the time of the deal, we indicated that we would do roughly $300 million of revenue in 2022. And that, as we said today, still remains our outlook. And we've now owned the business for a couple of quarters or almost a couple of quarters, and our conviction on that performance grows with each passing day. We love that business. It's very well positioned very similarly to our own single-use business in terms of the dynamics and the positioning, and we've even been excited by some of the early wins of kind of some of the cross-selling that we've been able to do there and some of the early synergies that we've realized. On the Ritter side, at the time of the acquisition, we said that, that business would do roughly EUR 225,000. And the reason that we specified it in euros was that business even today is almost entirely transacted in euros. It was a German-based business that serviced a handful of OEMs primarily in Europe. We estimated at the time of the deal through our diligence that there was somewhere in the range of 15% of the revenues were coming from COVID, and we had anticipated that those would play out of the business over maybe a 2- or 3-year period. So our internal models probably had those coming out more in like '23, '24. They came out almost instantly, which really gave us an opportunity, which we had anticipated to be able to move more aggressively after our synergies, to be able to activate our channel and to position these technologies with the end customers in life science research and in the various diagnostic workflows that they're supporting. So it's -- on the 1 side, there's been a bit of a revenue headwind relative to our models. But on the other hand, it really allowed us to focus more aggressively on the underlying reason we bought the business, which was to leverage our channel and to utilize this technology in this manufacturing side as a center of excellence for high-precision consumables manufacturing. We've made a number of investments that are in flight to expand the portfolio, given the customer access that we do have. So we're quite excited by the way that business is performing. If I take the EUR 225,000 and I adjust it for the 15%, which is probably closer to 15% to 20% COVID and I adjusted for the exchange rate, that business is growing kind of high single digits, which for those end markets that it's serving, those are going to grow from mid- to high single digits on an ongoing basis. So the core business performing very much in line and at the high end of what we would expect longer term for that business, and we're super excited by the momentum we're getting on the synergies associated with that deal.

And when you look at other future capital deployment, can you talk about your comfort with your leverage? I mean there was some -- if you -- if we flash back to March 2020, there was a lot of concern about leverage ratio. And it was going there, and the stock took a big hit on that. Can you talk about that? And also just from the M&A environment, I mean we started the conversation by saying that we've got -- the life sciences end markets are really good. I mean the valuations have all come down, but you've got this sort of like weirdness. It's like companies are desperate because their businesses are falling off right now. So it looks like it's probably a -- nobody is going to -- nobody has sort of had that come to Jesus moment yet where they decided they have to sell because the businesses are good, right? And they don't -- they know what their valuations are. So can you talk about those 2 things and just leverage and just sort of like the M&A landscape?

We're in a good position in that our business generates a tremendous amount of cash. Organically, we delevered roughly a turn a year, and we've done that consistently over the last several years. In the first quarter, it was roughly 0.25 turn, so right online again to do that again this year. It's a very resilient business model with more than 85% of our revenue consumable and specification-driven in nature. This is a very stable business and a business that in the private markets carried quite comfortably significantly higher leverage than what we run it at as a public company. We're undeniably committed to running it in this envelope of 2 to 4x. We're in that range today. And one of the reasons why we financed the Masterflex acquisition the way we did, which included a bit of equity, was to give us the flexibility to continue to stay active. We think that our shareholders are well served by the value we can create by building this platform via acquisition, and so we have continued to be active. And there's a lot of different areas that we like. Clearly, we like the bioproduction area, but we also like a number of the high-growth workflows in the lab. And we're somewhat inclined to try to expand our clinical services platform. We have some pretty unique offerings in there, including the leading biorepository franchise, a custom kitting operation that we run, as well as a pretty unique equipment and instrument platform that we run to service the clinical trial activities. So there's a number of areas that we think fit our financial algorithm, which is pretty straightforward. It's got to be accretive to growth. It's going to be accretive to margin, and it needs to yield a high single-digit ROIC by year 5. So we're in the fortunate position of -- I think we've got a lot of great areas to look at. We have a very full pipeline. We continue to be very active. But -- and I would love to do a deal this year. But if we don't, we can create a lot of value for our shareholders by delevering another turn this year and reducing interest expense accordingly. All of our variable rate debt, we don't have any early prepayment penalties or anything like that. So we've got a lot of flexibility, and I think both options create value for our shareholders. So we'll continue to be disciplined. We've not yet seen seller expectations moderate and come in line with maybe valuations that we see in the public markets. And I think there's probably a lot of different reasons for that, including all of our businesses are running at a high level. And so the market dynamics are maybe a bit different than some of the other scenarios where we've seen volatility in the equity markets in that strong end markets, strong business performance and strong outlooks makes it difficult, I think, for sellers to try to look at resetting their expectations. I think they're -- at least at the moment, they're happy to be patient. And given the strength of, generally, everyone's businesses, you don't really see a lot of assets out there that are distressed and needing to be sold.

Any questions from the audience? So one of the things we're getting asked a lot about, and this is because people have never seen Avantor perform over an economic cycle, it's like you mean you do have some economically sensitive businesses, you have some exposure to some of these markets. It's like how do you think the business performs if we go into a recession?

Fortunately, the business has got a long track record of long, stable performance and really demonstrating the resiliency of the business. If you go back to the '08, '09 downturn, the business held up remarkably well. I think at that time, the business looked a lot different. It was more research-oriented than it is today. I think it was off 1 or 2 points on the top line. EBITDA margins expanded given the number of levers that we can pull to address margins. So quite resilient. You're not going to see -- and even through the pandemic, the business performed extremely well, but it didn't have necessarily some of the really high growth swings up or down. And I think we like the makeup of this portfolio. Less than 15% of it is kind of CapEx-driven, which is definitely going to be susceptible if they're -- in times of a recession. We see that just like everybody else. We just happen to have less exposure. When our customers' lights are on, doing research and running their facilities, they're consuming my products, and it puts us in a pretty comfortable position in being able to perform well across cycles.

And with that, we're at the bottom of the hour. Thank you, Michael. Thanks, everybody, for listening. I appreciate your support. Have a great conference.

Thank you, everyone.