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

All right. I think we're ready to go. Welcome, everyone. I'm Matt Sykes, the life sciences tools and diagnostics analyst at Goldman Sachs. I have the pleasure of welcoming Avantor here today. We have Michael Stubblefield, the Chief Executive Officer. Move on toward Michael, thank you very much for joining us today.

Yes. Thanks, Matt. It's great to be here in person.

Maybe if you could help us set the stage initially and spend a few minutes Avantor, and including a brief review in the most recent quarter.

Yes, that's a great place to start and certainly appreciate the opportunity to talk about our business. Avantor is a really unique asset in that we're uniquely positioned to serve our customers from discovery to delivery. And we're embedded in virtually every stage of the most important research and scale-up and manufacturing activities in the industries that we serve. And I think there's a few distinctive aspects to the model that are worth calling out. Firstly, the end markets that we're exposed to are large attractive growth oriented. We have a total addressable market of over $80 billion. And more than 70% of our revenue comes from life sciences. And of that, more than 50% oriented towards the biopharma space. So really attractive end market exposure. And within those end markets, we're going to do 2 things specifically. Firstly, we're going to serve as a one-stop shop to enable our customers to deliver precise analytical results. And we do that through a really complete offering of products and services. The other thing we're going to do is we're going to leverage that access that we have into the early-stage research labs around the world to see customized proprietary content that ultimately gets spec-ed into our customers' production processes. I think the third thing I'd call out about our model is just how resilient it is and certainly, in a time like this, that is on your mind and it's important to understand. A lot of factors that lead to that. But importantly, we have a consumables specification-driven business model that yields a really sticky revenue profile. More than 85% of our revenue is recurring, which gives us some nice performance across economic cycles. And I'd be remiss if I didn't point out the customer access that we have that gives us access to more than 225,000 customer locations around the world. We're able to engage across these end markets with companies large and small. This is a really distinctive aspect of a model. And I think it makes us an attractive partner for our third-party suppliers as well as from an M&A perspective, which we'll talk to in a bit here. So we love the model and the positioning that we have in a really attractive space. You mentioned kind of Q1, the year is obviously off to a great start. We delivered 7% core organic revenue growth, 140 basis points of margin expansion, about $0.38 of earnings. And I think that just highlights the continued track record of execution that the team has and the ability to execute in a pretty challenging environment. So we're excited about the business and certainly off to a great start this year.

Great. And maybe given that we're in closing of Q2, just maybe share a bit about your outlook for Q2 and the full year and how that's trended so far?

Yes. I think I'd start by just reiterating our confidence in the full year guide that we updated at the end of Q1. On that earnings call, we mentioned we committed to a 4% to 6% organic revenue growth. More than 125 basis points of margin expansion for the full year, and we updated our EPS range by a couple of pennies at the midpoint to $1.48 to $1.54. And certainly, as we move through the second quarter, nothing we've experienced here would cause us to think differently about that target, and we remain very confident about delivering on the guide for the full year. The second quarter core demand continues to be very robust. We would anticipate, as I indicated, on the first quarter call, core organic revenue growth to come in the same range as what we saw in Q1. And we're going to see really strong margin expansion again in the quarter similar to what we did in the first quarter. So the demand fundamentals in the core business despite some of the macro noise and continued operational challenges that we see and have been seeing for the last couple of years, we remain very confident about the quarter.

Great. Maybe a big picture question. I think back to the IPO a number of years ago, you set out a few goals, reset organic growth rate higher, delever and expand margins, and you've been able to deliver on all 3 of those thus far. But I feel there's more to go. And so as you think about these goals, what has changed in terms of your priorities as you look out the next 3 to 5 years for Avantor?

Yes, it's been quite a journey. And for any of you that have followed the story, hopefully, you would agree. Since the IPO we just crossed the 3-year anniversary of the IPO here about a month or so ago, the business has exceeded or certainly met all of its objectives. I think the 3-year top line CAGR for the business has been around 7%, and the margin story has been incredible. At the time of the IPO, the combined margin of the company was around 17%, 17.1%, somewhere in that range. And we just came in just under 22% last quarter at 21.7%. So significant execution of our synergy plan and delivering on the organic growth levers that lead to significant margin expansion. And we generate a lot of cash. The business has delevered rapidly, roughly a turn a year. And at the end of the first quarter, we were within our target leverage range of 2 to 4x. So I would certainly agree with the comment that the business has exceeded all of its objectives that we set out to accomplish at the IPO. And we're at, I think, at an inflection point here in that having just gone through now the conversion of the mandatory convertible that was kind of the last element of that IPO, if you will, that recently converted. We're kind of now view the IPO and all the integration activities with VWR kind of in the rearview mirror. There are some things that will stay the same. I think our financial algorithm still holds that we talked about at our recent Investor Day in September of mid-single-digit organic growth, 50 to 100 basis points of annual organic margin expansion, strong free cash flow with roughly a return over year of deleveraging. We're still quite optimistic about that algorithm that yields then kind of mid-teens, mid-teens plus EPS growth on the back end of all that. So a pretty attractive financial algorithm that is fully intact. When I look at what has changed and kind of what we're focused on, Clearly, it's a growth-driven story. And with the work that we've done and the positioning that we now have, I think the most obvious change is M&A. We were able to deploy $4 billion of capital last year in closing 3 transactions, and M&A will continue to be an important part of our go-forward growth strategy. We talked at the recent Investor Day about the firepower that we'll have off of this platform and just how well positioned we are as a strategic buyer in this marketplace with multiple vectors to invest in significant capacity to do so. And a platform that I think is attractive. I mentioned earlier the customer access that we do have, we're a natural aggregator of content and can accelerate the growth is most every asset that we would come across. I also think when I kind of reflect on where we're at today strategically and where we were at, at the time of the IPO, certainly, a lot more time spent on innovation and new product introductions that you see us talking a lot about that, that certainly has probably a different level of prominence in our business today than it had historically. And we're proud of the work that we're doing on sustainability. Hopefully, you've had a chance to peruse our recent sustainability report that's out there. This is our second version that we've put out there. So I think with the investments that we've made in capacity and growth and capabilities around the world, we're really well positioned to continue to grow this business.

Great. I think just shifting over to bioprocessing. Maybe talk a little bit about the extent of your GMP footprint. I mean, we've done some additional work in this space. And one thing that we kind of understood is that GMP is starting to be used earlier in the process, replacing some RUO at some point. But also if you look at the maturity of the cell and gene therapy pipeline and the need to move to GMP at some point during that process, it looks like there's going to be an even greater need for GMP kind of capacity. Could you just talk about how Avantor's position to absorb and grow this capacity over time relative to your competitors?

First, I really appreciate the recognition of the importance of GMP to this end market. This has been a trend that we've seen even in the monoclonal space of customers wanting to use GMP materials earlier in their development cycles. It's almost given that they're going to use them during their production process. But what we have seen over the last 5 years is a pretty aggressive move towards wanting to use the exact same materials, certified from the same exact quality systems off the same manufacturing assets that they're going to use on the full-scale manufacturing process once it all gets approved. And that really does play into our strength and our strategy. We have, as a company, more than 30 GMP facilities around the world, and we continue to expand that. And we've got an announcement that we made earlier around a GMP investment in Ireland that will come online later this year. And we recently announced, as part of our Q1 earnings call, the investment in a new GMP facility in Singapore, for example. So strategically, we are investing in ensuring that we have the assets positioned as close to our customers as we possibly can to meet their needs. You mentioned cell and gene therapy. There are some nuances associated with those workflows that make the quality of the materials even more important than in the traditional monoclonal antibody workflow. In these processes, you don't have some of the harsh viral clearance steps that you would have in the monoclonal workflow that enables you to eradicate any of the impurities or bacterias that might be might be present there. And you're dealing with single patient manufacturing processes in some cases. So the premium that's placed on quality is enhanced in the cell and gene therapy workflows. And our whole business model is built on producing materials at the highest purity possible in a highly regulated environment in our GMP facilities around the world. This will be a strategic competitive advantage for us going forward. And we saw this as part of even in COVID time here as we were all working quickly to launch the mRNA vaccines, there were a lot of those materials that were not GMP. And that was one of the bottlenecks early on when we saw the pipeline developing, one of the big concerns around the mRNA vaccine was whether or not the supply chains could mobilize GMP quality product quickly enough to meet the demand. And obviously, we were able to do that, and we were a big part of that.

Great. On the demand side, we were at dinner last night had a lot of questions around this. I think when you look within bioprocessing and you kind of look at the composition of demand. Do you get there any sense that there's been some inventory stocking or shift in stocking levels or even destocking or a pull forward of demand because customers looking to secure supply to the supply chain constraints. Or the demand pattern has been fairly robust and consistent. I think there are a lot of questions about the composition and durability that we are seeing given what's going on in the macro environment. So any light to shed like [indiscernible] that would be great.

Yes. Over the last couple of years, the demand has clearly been quite strong. And all of our supply chains are constrained both from a capacity standpoint as well as a material availability standpoint. So we had to be pretty close to the ordering patterns of our customers to ensure that we were allocating and managing our capacity and availability in a fair and equitable way and to ensure that we were able to support all of the various therapeutic platforms that are important to our customers. So it's something we've paid a lot of attention to. And we have a pretty unique position in that we would have more than 1,500 of Avantor associates that work at our customer sites every day as part of their normal work of -- and in many cases, we're managing our customer stock rooms and even in many cases, we're doing the ordering of their materials and replenishment of their stocks for them. So we have a pretty privileged position, I think, to see what's going on there. It's certainly not perfect, and I'm sure there's the odd outlier here or there where customers have been able to cover their demands with a bit of extra inventory. But in most cases, and the materials are just not available. We've restricted customers to buying kind of ratable quantities in those categories that have been constrained. And we have the added complexity that, in our case, being a material-centric supplier like we are, many of our materials have shelf life and need to be stored in highly controlled, regulated environments that would be part of the customer's regulatory filing process. So it's not like they can go buy a bunch of materials and just put it out in a temporary shed in the back without risking, violating their approved processes. So it does become kind of a just-in-time delivery model, which speaks to the strength of our supply chain and having as many distribution centers as we have in the ability to execute a supply chain real time. The composition of our order books, particularly for our long lead items has changed over time. I think going back a year, 1.5 years ago, probably a quarter of, say, the bioproduction order book was COVID related. And as we have kind of moved through COVID, that has shifted to being more strongly dominated by the core business. And today, probably 15-ish percent or so of that order book is COVID related and the balance is core business. The underlying demand fundamentals of all these end markets continue to be robust, and we just don't see any visible signs of destocking or building of inventory or these kinds of trends. We watch it closely. We don't have perfect visibility, but it's certainly not something that we think is a material driver of the business today.

Maybe on pricing, the enacted price increases in the end of last year, you're actually able to realize those higher prices a lot earlier than we had expected in Q1. I think it's more to come through in Q2. Maybe talk about how investors should think about price realization and additional actions you could take over the course of this year? And how much that could actually add to some of the top line growth we could see this year? I mean how much of that is actually in the guide for '22 in terms of additional price actions you might take?

Yes, sure. So probably take you back to the financial algorithm that's rooted in a consistent kind of 50 to 100 basis points of organic margin expansion every year. And there's probably 2 or 3 different drivers of our ability to do that. Certainly, with the scale of our business, we get some pretty meaningful operational leverage in the business that supports margin expansion. The mix of our business is important. Our proprietary products certainly come with a higher margin. And because they're disproportionately oriented towards our production platforms, they grow faster than the rest of the portfolio. And so that's certainly a driver of margins. And then as you suggest, our kind of pricing and commercial excellence acumen is an important driver here. And we would certainly be looking to offset any inflationary pressures that would be in the business, whether that be raw materials or labor or few other things through the pricing actions that we take. Given the complexity of our portfolio with more than 6 million SKUs and as many customers as we have, you have to have a pretty sophisticated approach to this. And we have some proprietary AI-driven tools that we use to give us the insights that we need to be able to manage that on a really dynamic and real-time basis. Our commercial agreements are structured such that we can be agile in a normal environment, which we're not in, obviously, pricing would typically comprise about 1/3 of our growth. And volume would comprise the balance of the 2/3. That's probably flipped this year, given the pricing that we've had to drive into the market to offset inflation, as you indicated. We kind of started the year with our normal cycle of kind of in the fourth quarter leading into the year announcing pricing that we wanted to put in place effective January 1 for any new orders. And in a normal year, that would probably be sufficient. When things are a bit more stable and you don't have as many adjustments that are coming your way that cause you to kind of go back to the marketplace. We've had to go back to the market multiple times, not across the board, and we certainly don't do it in a peanut butter approach, where you're spreading the same increases everywhere. But within pockets of the business, we've had to go back and adjust pricing multiple times. And I would anticipate us continuing to need to do that throughout the year as the situation evolves. And as long as inflation continues to come at us at the rates that it's been coming at us. It's going to be something that we're going to have to continue to do. Fortunately, we have the tools, the processes and ultimately, the flexibility with our customers to be able to do that. And as I suggested in our outlook for the full year, we anticipate being able to deliver on the 125-plus basis point margin expansion for the year, including contributions coming from our core, it won't just be M&A. We saw that in Q1, and we'll see it again in teams got a long track record of being able to manage inflation with price.

I mean you've addressed a little bit on margins, but it's one thing that we think is that there's this idiosyncratic mix shift that boost the margins. And I feel like if you look at the valuation of Avantor versus peers, it's that margin differential, which would be one of the things that might be holding it back. And each year, you set out these targets that you beat very handily. And we've got 125 basis points for this year and then you've got a longer-term view as where they should be in a few years. As you think about your ability to expand margins, do you feel like that 125 basis points is very much a floor? And that when you square that with what you were looking for in the next couple of years on a longer-term basis, there seems to us, at least, be a significant amount of upside on that margin expansion based on what you're doing organically and then potentially inorganically later on. But just talk to us about where you feel like those margins can actually get to and how you can get there.

Yes. It's a great question. It's certainly an important part of the value creation that I think that we offer off this platform. So I've talked a little bit about the 50 to 100 basis point organic margin expansion. And we've exceeded that pretty much each of the 3 years that we've been public. And despite the inflationary environment that we find ourselves in this year, we're highly confident we'll do that again in 2022. On top of that then comes the contributions from M&A, which we were fortunate to be able to return to M&A last year with -- given the flexibility that our balance sheet gave us and we would anticipate being able to do more of that going forward. So to get to the 125 basis points this year, it's a combination of our normal expansion from the organic levers that I've outlined and it will include the contribution from the 3 acquisitions that we did in 2021. I do view 125 as the floor for the year. We did 140 basis points in Q1 despite the fact that not all of our pricing had taken into effect. There was a significant amount of our revenue that was still coming through at the old 2021 pricing, just on the way that we transact with our customers. That kind of comes out of the business as we move through the quarter and into the second quarter. And Q1 in -- from a margin perspective was our most difficult comp. The margins were a little bit lower sequentially throughout the year last year. So despite the comp and the environment we found ourselves in, we're still able to expand margins 140 basis points in the quarter. So we're very confident in delivering on that again this year. In September, at the Investor Day, what I outlined in terms of our long-term view of where margins will get to off this platform. We based it on what assets that we had in-house at the time. So not willing to speculate on what may or may not transpire from an M&A standpoint. And we updated it at one of your competitors' conferences in January, once we had closed the Masterflex deal. And so what we said at that point then with the business that we're sitting here today with having closed those 3 acquisitions and then the legacy platform, just executing our organic algorithm gets you to more than 24% by 2025. And you can see that we're well on our way. We almost did 22% in the first quarter. And I think we've got a great track record of delivering on this expansion year-over-year. To go beyond that, I think being -- having any level of success in deploying the $8 billion plus of capacity we have from an M&A standpoint, which would be preferentially oriented towards buying proprietary technologies and the margins that come from those assets would only accelerate that. So clearly, we have a strategy here that's rooted in continuing to drive those margins up. Very, very confident in getting to 24% just with the businesses that we have, and we'll look to accelerate that through M&A.

So that's -- I think in terms of acquisitions, RIM Bio, Ritter, Masterflex. If we look at Masterflex, I think you commented about it being embedded within the private equity organization than it was before, and there was systems and integration, things like that, that had to be done. Could you kind of give us a mark-to-market on where you are with the integration of Masterflex in terms of getting it fully integrated with the Avantor from his previous owner.

So Masterflex closed in November of last year. So we're 6, 7 months into the integration of the 3 deals that we did, it was the most complex from an integration standpoint in that it is a carve-out from Antylia Scientific, which is a GTCR-backed business. The business was deeply embedded with the assets that were left behind. So it's been a pretty fulsome lift. And of course, we knew that going in through the diligence and have planned it out pretty carefully. There are a number of transition service agreements that are in place that will kind of carry us through the 12-month mark, if you will. And there's a number of milestones that we're tracking along the way here so that we're swapping off of these services and providing those ourselves here on a kind of a continual basis. We just eclipsed 1 of the more important milestones from an ERP standpoint in that we shifted the European part of the business and a good portion of the business in Asia onto our systems. We did that a number of weeks ago, and it went seamlessly. So we have these types of activities, integrating their inventories into our distribution and warehousing footprints. So that is all kind of going according to plan. We're ramping up, resourcing on our side to take on all of these services. And I think we're in really good shape to complete that, at least meaningfully complete the -- or substantially complete the integration by kind of the 1-year mark. So that's going well. From a commercial standpoint, it's where we really hit the ground running. Our -- the Avantor fluid handling platform that's within our bioprocessing business, knows this asset extremely well. And the teams have matched nearly seamlessly. We've got some early wins that we've been able to take advantage of pull-through from both sides of relationships that were in place. And we're now taking an integrated end-to-end fluid management solution to the marketplace today, which our customers are super excited about. There's some great innovation on that platform that we've been able to accelerate and help out in bringing some of the new products, particularly for some of the bioproduction processes. Some of those things are coming into fruition. So we're really excited about the platform and the integration is off to a really good start.

Great. I will say that if there's any questions from the audience, feel free to raise your hand. We've got a microphone, happy to take questions. When I think about...

Just kind of a quick question. You talked about kind of your capital deployment a little bit. You talk -- we can [indiscernible] you talked about your capital deployment a little bit. What are kind of your thoughts about like ratings and stuff like that? Are you targeting anything? And where you kind of want to settle the business? Obviously, it's going to cliff into ground with it, stuff like that. Is there sort of a target that you guys are kind of going after in the medium term?

No, I don't think anything specifically. I think we're -- we've made a lot of progress with our balance sheet over the last number of years, we're now within our target leverage range of 2 to 4x. We intentionally finance the Masterflex acquisition with a bit of equity to ensure that we have flexibility to continue to be acquisitive for the right opportunities. And we're committed to running in this range. Tom and our finance team have done a great job in laddering our debt and giving us a lot of flexibility in terms of maturities pretty far out in the future. And I think we have some pretty attractive rates in the business today. So I think we've got a lot of flexibility, and I think we're comfortable with where we're at there.

Great. And just sticking with M&A, just for one more question. I think about the competitive advantage you have with the VWR platform. And as you approach companies that might not have as large of a distribution capability, how much of a competitive advantage is to get those types of companies to close those type of companies because of the platform that you have. And then when you plug them into the system, is it just a pretty quick uplift in terms of what you see in terms of revenue growth for those acquired companies?

I think this is one of the more strategic aspects of our platform that we run here. This -- I mentioned at the outset, the importance of our customer access. We really do have unparalleled access to research customers around the world. And with the trends that have evolved in the drug development where it's not just the large pharma players that are doing the development. More than 80% of the new molecules are being developed by pre-revenue companies in small labs scattered around the world. So access particularly in a material-centric business like ours where you're needing to engage with your customers, customized solutions that you can earn those specifications. And all that happens in early-stage R&D. This access really is an important part of our model. And ultimately, what drove the combination of the legacy of Avantor in the VWR business back in 2017. Now when I think about our positioning as a strategic buyer I think there's a couple of things that are important here. One, we don't have a lot of encumbrances from an antitrust standpoint. So I think our ability to move quickly and to close quickly positions us favorably in this space and certainly is important to buyers. But our platform, not only in the access that it gives us to customers, but the global nature of our platform is really attractive. And I think about the 3 deals that we did last year, at least in the case of Ritter and in Masterflex. The ability to expand the customer access and the customer portfolio was -- were important considerations for both of the sellers. In the case of Ritter, that was primarily an OEM-driven business model. just within Europe, not a lot of exposure in the U.S. or in Asia. And so to your point, instantly upon closure and actually, we were actually doing the work even before we closed to start to get ready for it. we're able to drop in the Ritter technologies alongside the rest of our content across thousands of customers, and dramatically change the profile of who we could serve with the technology. Complete game changer. And we'll leverage that platform to not just take the existing portfolio to more customers, but we'll leverage the capabilities and bring new technologies. We've made investments to expand that portfolio, and we'll do that in the exact same customers and the exact same application areas that we sell the rest of our content. So it is a natural platform for us to be able to continue to put more content across and expand that customer base. The time that you actually start to see the benefit somewhat depends on the nature of the technology. I mentioned earlier that how resilient our portfolio is and how sticky it is. One of the reasons why it's so sticky is most of what we sell even in the lab becomes some part of a qualification or an approval or a specification process from our customers. So even on something like Ritter where we're selling robotic tips for high-throughput liquid handling systems. Those are highly specified and go through a pretty extensive qualification process. In some cases, could be depending on our partner could take up to a year to earn those specifications and to get them to switch to our materials. So for all the reasons why we like the stickiness and what it means from a resilience standpoint, it does create just a little bit of a lag here and earning those specifications. But you're not talking multiple years. In most cases, you can do that in -- measured in months or quarters.

Maybe I don't want to ignore other parts 25% of your revenue for advanced technology. You mentioned significant TAM growing to mid-single digits, and there's obviously some constraints in the semi supply chain and aerospace and defense is a little bit less sickle. Maybe talk about your expectations for this segment in '22 given the macroeconomic environment. And should investors look at this segment, maybe it's a little less cyclical than they previously had viewed because some of the underlying growth drivers within this business.

Yes. So the applied part of our business is about 1/4 of our revenue, and this part of our business is accretive to growth and significantly accretive to margins. It's a part of the business that we like a lot. And it does maybe perform a little bit differently than what you might intuitively expect it to perform given some of the application and end markets that we're exposed to. Of the 25%, probably half of that is going to be in end markets and application areas that you might consider to be a little bit more linked to GDP. And then you have probably the other half of the platform that's going to be more defensive growth oriented. And an example of something I would put in that category of defensive growth-oriented would actually be semiconductors in the way that we play it with our customized materials. We're seeing strong double-digit growth in that part of the business. So our expectations for our applied business is quite bullish in that, yes, I'm sure there's going to be a few of those application areas that could come under some pressure from a macro standpoint, but we have enough of a mix there and diversification of multiple end markets like semiconductors that are growing double digits for us that we expect that end market performed quite strongly for us this year from both a growth and a margin perspective.

Great. We're out of time. Michael, thank you very much. Appreciate the conversation.

Excellent. Thank you.