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

Good afternoon, everyone, and thanks for joining us at the Raymond James Institutional Investor Conference. I'm happy to be joined by Avantor, we've got CFO, Tom Szlosek as well as CJ Jones and Blake Montgomery in IR in the audience. I'm going to keep it quick and brief and pass it over to Tom for a presentation. We may wrap up with some Q&A if there's time, but I'll pass it to you.

Thanks, Andrew. As Andrew said, I'm Tom Szlosek. I'm the CFO of Avantor, I've been with Avantor since December 2018. We did our IPO in May 2019 and it's been quite a time frame coming right out of that into COVID. So we're happy to be here to tell you our story. As Andrew said, you have CJ from our Investor Relations, who runs Investor Relations for us. I encourage you to get to know her. She has all the answers, all the information. I'll do my best here. So I want to thank Andrew for having us and to the Raymond James team for inviting us. And today, what I'm going to do is give you an overview of Avantor because I know some of you are not as familiar with the story. I'll try and be as educational as I can as well as talking about our financial algorithm and maybe some of the more recent trends. So with that, a couple of things on the obligatory statements around forward-looking statements. We do -- you'll hear me make some forward-looking statements. They're subject to risk. I encourage you to read our SEC filings, our 10-K for our risk factors and cautionary language there. We also use non-GAAP measures where we think they can be helpful to you as investors. I'd encourage you to consider those non-GAAP measures with the relevant GAAP measures as well? So let me start with a little bit of tell you a little bit about Avantor. I think if you take away nothing else, you should really remember that we're ubiquitous when it comes to our customers' research activities in their new product development as well as research as well as in their analytical testing of products off the production line. That's one part of the business. The other part of our business is the ingredients, including chemicals and single-use type offerings that we provide for our customers' production platforms. And I'll talk a lot about biopharma in a second, but the biopharma industry continues to have healthy growth rates. We continue to be well represented and it's a nice source of recurring revenue. So we're -- we have 6 million SKUs just to put that in perspective on the research and production side. As the slide says, we're about $7.5 billion in revenue. Enterprise value is about $25 billion. We're based in Radnor, Pennsylvania, just outside of Philadelphia. I'd say 95% of our business is in the Americas and in Europe, although the fastest-growing piece of Avantor is in EMEA, Asia, the Middle East and Africa for us. 75% of our -- or 70% of our revenue comes from Life Sciences. And the underlying industry fundamentals in life sciences has not changed. That's continued to be a nice growing industry where there's a lot of innovation going on and where our footprint in both that research side that I talked about as well as production positions us nicely to enjoy the benefits from that industry. We're a product of a merger in 2017 between VWR, which was a distribution company and Avantor, which was a smaller chemicals manufacturing company. And at that time, we were decidedly weighted towards being a provider of third-party product through our distribution platform. You fast forward to today, more than 55% of our revenue is actually our own offerings, meaning that we develop it, we manufacture it, we produce it and distribute it. So this proprietary part of our business has the higher margin rates, as you'd expect. Our overall gross margin rates are about 35%. But on the proprietary side, it would be much larger. And that part of the portfolio is growing almost 2x the third-party piece of it. And it's a place where we have a significant amount of our innovation funding. The last thing I'd point out about Avantor is that 85% of our business is recurring, meaning that we're not selling a significant number of analytical instruments or CapEx. Most of what we have is materials in nature, it's consumed. And so you get a nice reorder pattern, a nice pattern of repeat business, which we find to be pretty attractive for the model. I talked about 70% of the business being in Life Sciences. And what we mean by that is the biggest part of this circle here, which you see is biopharma. So we serve -- the aggregate markets we serve are about $80 billion is the way to think of it. There's many life sciences tools competitors that we would have similar products to, but there's no one life sciences company, I would say, is identical to the other. And so our definition of what our market is would be probably different than some of the other providers just by virtue of what they provide in their portfolio. But the end markets we serve are about $80 billion. The principal ones being biopharma and what you can see is about 55%. It's got a high single-digit growth rate. So I think between 7% and 9% growth in the biopharma side. And what's interesting is you can bifurcate that between research and production. And the research side is probably a low to mid-single-digit grower. The production side is rated for us at a mid-teens grower, and it's actually grown even greater than that in the last few years. I'll show you in a little bit here. So in biopharma, we're a one-stop shop. Our customers can come to us for their labs and get everything that they need in their labs, and I'll talk about the specific products examples that we have in a minute. And then on the production side, we make materials, custom materials and single-use solutions for bioproduction. The other part of this -- what makes up the rest of the of the life sciences is this health care that you see in the upper right of the slide, it's about 10% of our business, growing at mid-single digit, similar offerings that we have in the health care as well as some proprietary materials that are used in medical implants, proprietary medical implants that have a nice growth dynamic to them as well. We also serve education and government. So those 3 combined roughly speaking, is the life sciences exposure that we have. We also have significant exposure, as you can see, to an array of industrial end markets in our advanced technologies and applied materials as part of the portfolio. It's about 1/4 of the business, grows at a little bit better than GDP, so mid-single-digit kind of growth rate is what we see there. When I explained to people, the objective of -- what Avantor's objective is in serving its customers. It's pretty simple. Our products and our services are enabling research and product development. The aim is to continue with our customers through the research process and get specified onto their platforms, under their production platform. So in biopharma, the obvious example is being specified into a pharmaceutical product that's on the market. And these -- this is where our material offerings can provide a nice continuing set of revenue streams for us at some pretty nice margin rates, as I said earlier. So for labs themselves, on the left hand of the slide, think about it as either a research lab, where new product development is ongoing by our customers or like an analytical testing lab where a product that comes off a production line, for example, in a food and beverage customer, it needs to be tested. They need to do a lot testing and most of what you see this manufacturer needs to have lot testing done, and they'll have labs for that. And we have a pretty good presence there. So some of the examples that we have are a variety of chemicals and buffers and other types of chemicals that will be used in testing. We also have liquid handling components like think of a pipe or a dropper or a beaker or plates, they're used in a research lab. There's analytical instruments. There's personal protective equipment and cold storage kinds of devices. So you walk into a lab, anything you'd see there, we probably either make it ourselves or we arrange for our customers to have that. And again, it's that one-stop shop that works well with them. We also provide some services to our lab customers. Inventory management is an example. But we also do some media preparation, sample handling on behalf of the customers as they look to become more efficient in their operations. So on the right-hand of the slide is production. So we're on labs, we're all about analytical precision and trying to get -- help our customers with some precise analytical results. On the production side, the calling card is high purity -- high purity and high regulation are the environments that we're operating in. So if you want to be on a drug, a biologic drug, it's going to have some pretty high standards for you to be able to meet consistently. And we've been at this for years and have a pretty good competitive position. The materials are usually customized. And oftentimes, they're coproduced with our customers themselves and their development activities. The example -- some of the examples that we have that are in the production side include you would use to grow a cell because a monoclonal antibody type drug production, you start with the cell. You need to grow the cell and harvest the cell. And while we don't provide the cells themselves, we provide all the ingredients that are necessary for them to grow and to be harvested and cleared. We make peristaltic pumps and the consumables that go along with the pump. And these pumps are what allows the materials to work through either research process or a production process. So most times, you can't have the materials that you're manufacturing actually touch a pump, and so it's got to be encased in the specialized tubing and it's the tubing that goes through these pumps. We're the #1 or #2 maker of these peristaltic pumps in the world, very strong position and it's helped us well. Third example, as I mentioned earlier, in some of the specialty silicones that we have for the health care market that are used for in situ kind of medical implants. So again, that's our business model, and it's a comprehensive offering that we think takes us from the beginnings of research all the way through to our customers' production activities. So what makes us successful? First of all, the industry is -- we have to start with the industries we're serving that 70% that's life sciences is healthy. It's been healthy for years. There's a significant amount of innovation dollars that continue to go there and it plays well with our portfolio. So for starters, you're going to be serving markets that are growing. Our position is equally as strong. If you start with the upper right block on this puzzle, we have like unparalleled customer access. We have over 3,500 sales associates globally that are -- that work with our customers are at their sites. And think of it as more than 300,000 customer locations around the world that we're -- we're serving every day. To be able to have that kind of access with your team makes us a pretty attractive place for our partners that are providing product to get to the market and a couple of examples. I'll give you in a minute. But on top of the actual traditional sales footprint, we have world-class digital marketing platforms and e-commerce platforms that serve us well. And we've been at that for better part of a decade, and our customers are significantly engaged with us on those platforms. And I talked about our 6 million SKUs in terms of the portfolio itself. Our global infrastructure, we've got probably 30 or so manufacturing plants, and we've got about 50 distribution locations. We've got in the teens, probably 15 or so innovation centers, and these are strategically located to be near our customers, and they facilitate that collaboration process that I talked about as our customers are engaging in their new product development activities we're right there with and we can -- we have labs, we have pilot manufacturing sites that we can work with them to collaborate on new molecules and testing our products and for efficiency, quality, regulatory standard safety and everything. And the last is in the upper left is our broad team of material scientists. We have process engineers, other experts that are there that know our customers' development activities very well and our critical resource for their -- for that development. Obviously, regulatory is also a big part of this. And so we have a strong regulatory team as well. In terms of the enablers that we have in place, and I think will help us to continue the growth that we've enjoyed. I talked about a few of the last page, but we have a customer-centric innovation process, and I've talked a little bit about that. I'll give you a little bit more color on that in a second. We are investing organically, and we're investing in M&A. Obviously, we prefer to do everything organic and develop those portfolio of proprietary products on our own. But there are a lot of cases where you get to market quicker, you build your portfolio quicker, you get better customer interaction and engagement through M&A. So we've -- we've got both of them as drivers. And let me double-click on a couple of each of these. So if I start with on innovation, our model is very unique. As I said, we're not out there introducing our own new products like dozens of new products a month. We're collaborating with our customers in their introduction of their new products. That's what we do is kind of a little bit behind the scenes. And you can think of it as us providing new product formulations, helping them to achieve new purity specifications or packaging innovations, things like that. That model has positioned us very well. We're on 85% of the top 20 pharmaceutical drugs that are out there on the market today. We've maintained that position. So as things come and go, we're continuing to be partnered with new products hitting the market, very well positioned from the other facets that I talked about. We also work with partners that do their own product innovation, and we're not necessarily involved in the innovation itself, but that customer access that I talked about earlier, helps us to help our customers get their products to the market. And I've cited a few examples that you can see on the lower left part of this slide. So over the last year, we've helped Agilent, Cytovance, GeminiBio, Oxford Nanopore, just to name a few to bring their new products to the market, think of those 300,000 customer locations that I talked about. And it's a pretty clear reason why they want to be partnered with Avantor. In terms of expansion to support the growth that I've talked about and the idea of developing our own product, we've tripled our CapEx in the last few years. We're still interestingly a low CapEx model. We probably -- it's been 1.5% to 2% of our revenues on CapEx. So it's -- we're not hugely capital-intensive, but we're finding that we can drive better growth with some of these organic investments that we're excited about. On the M&A side, we fully integrated Masterflex, Ritter and RIM Bio. Those are acquisitions that we did in 2021. And they're -- they have very attractive portfolios, again, proprietary product that will develop and manufacture on our own. These acquisitions are accretive to Avantor in terms of long-term growth rates and in terms of margin expansion. And these are the types of deals, these tuck-in type of opportunities that we would expect to continue to pursue from an M&A perspective. We're building a world-class strategy and M&A organization. When we started after the IPO, we had 2 people in the M&A group -- M&A and Strategy group. We've since brought on a world-class leader in strategy and M&A. She started -- Kitty Sahin started with us in the fall of last year. and she's building a team that's going to be 5x the size of what we had traditionally had. And the skill sets are very impressive the folks are bringing. Some have technical product knowledge, some of them are great at transactional M&A stuff. Some of them are due diligent specialists, modelers. And it's going to be -- it's going to help us going forward. So in the near term, I get the question a lot about the current environment that we're operating in. We're committed to M&A. That's between organic expansion as well as M&A, that's where most of our capital allocation is going to go. And if those opportunities are not there, we'll be delevering. And I think 2023 is probably a year that's going to be more heavier weighted to delevering. Just because of the environment we're in, we have a portfolio of debt that's pretty fixed. It's like 70% of it is fixed. We got most of our portfolio refinanced just before this wave of interest rate increases came into effect. So we feel fortunate that we've got a nice footprint there. But 30% of it is subject to market rates. And as you know, there were probably 400 basis points of interest rate increase in '22. There's probably another 100 or so 75 to 100 on the horizon here. So it behooves us to apply our cash, the cash we generate to delevering in the short term. But again, full commitment to investing and doing what it's going to take to enhance our portfolio. I want to just touch a second on ESG. As part of our core growth strategy, we're investing in our sustainability platform. It's pretty important to us. And we've made significant progress in 2022. From a GHG perspective, when you look at Scope 1 -- 2 years ago, we set out -- we wanted to be very tangible in terms of what we thought we could achieve in a very short time frame. We said, let's reduce our GHG emissions within 3 years by 15%. And we're ahead of that. And I think when this -- by 2025, we'll have accomplished our -- that goal. And like I said, we're halfway there now. We're also -- I mean, we also pay a lot of attention to what the rating agencies are looking for from us. We've continued to make good progress from the ones that you see. And you can expect to hear more from us on sustainability. We do a regular annual sustainability report comes out typically in the May time frame. And you'll hear more about what our thoughts on Scope 2, Scope 3 emissions and what we're doing overall for the -- for the environment and to maintain that sustainability. Let me shift to our long-term financial goals here. This is the algorithm that we've talked about since the IPO. We're a mid-single-digit grower from an organic growth perspective, more or less in line with the market, maybe a little bit better. And when I show you the actual results in a second versus this targeted range, you'll see that we probably have done better in the market. We have significant EBITDA margin expansion opportunities. If you compare us to the peers in the group, you would say. Well, first thing you'd say is, wow, you guys have made an amazing expansion in the last 4 years in terms of your EBITDA margin. But secondly, they'd say, you're still below your peer group, and we agree. We think we have 50 to 100 basis points of opportunity a year in expanding our margins. And we do it from basically 3 sources. One, we get really good leverage from the volume that we have. We have a fairly fixed cost footprint. I mentioned our CapEx load is not high. And so we're able to get some decent leverage volume growth. Secondly, we have a mixed benefit going on here. I mentioned that our proprietary products are growing twice the rate of our third-party products. Those proprietary products have superior margins to the third party. When you get more of those, you get nice contribution to your margin rate, that's helped out nicely. And thirdly is pricing. We call it commercial excellence. But for us, there's really 2 ways that we get pricing. And it's a real -- it's a pedigree of VWR as a distribution player. The systems and the skill sets and the algorithms that we have around pricing are world-class. And on -- from the legacy of Avantor side, equally strong in terms of managing the dynamics around pricing opportunities. So you get -- of course, you have inflation and inflation is sort of the starting point for our pricing discussions. But given our placement our production platforms, our customers' production platforms, we're pretty low on the amount of the bill of material that we occupy, we're a very small component of customers' product cost. And we've done a lot to get specked in. We've done a lot of collaboration work, 2 or more years of collaborating to get specified onto those platforms and meet the regulatory requirements. And so you have a strategic pricing advantage there as well. So it's both offsetting inflation and doing strategic pricing. So with that, our net earnings should grow in the mid-teens. Operating profit, obviously, is driven by the 4% to 6% and the 50 to 100 basis points. We also continue to reduce our interest expense. We're still modestly levered at 3.7x at the end of 2022, but that has come down from over 5x in the short order of 1.5 years, and it says that we generate a lot of cash and when we're delevering, that creates additional income opportunities for us. Our free cash flow generation is very strong. We target 90% free cash flow. I talked about our priorities on capital allocation. And I think we're in a shorter window here where it's probably a little bit more leaning towards debt deleveraging until I think the M&A markets improve for us. So that's the overall capital allocation model. If you look at how we've actually performed against those targets, so against 4% to 6%, our CAGR has been 6.5%. Against the 50 to 100 basis points of margin expansion, we've done about 130 margin expansion a year. We've gone from 17.1% EBITDA margin, as I said, to 20.9% at the end of '22. So nice healthy growth there. Our adjusted net income CAGR has been over 35% and our free cash flow is more than doubled over that time period. So the -- we're ahead of what we set out for ourselves as our targets, and we continue to revisit the targets as the portfolio complexion changes, perhaps you'll see an update. But right now, we're comfortable with the way we've articulated that. If I then turn to 2023, the thing to keep in mind is that our long-term growth algorithm hasn't changed, but '23 is going to be a little bit different for us. We went through a detailed walk-through of our guidance in our Q4 earnings call. So I'd encourage you to listen to the transcript on that. Nothing has really changed since then. The guidance reflects a strong end markets that we serve. So our customers in biopharma, for example, are doing fine or customers in health care, they're all doing fine. The -- we also have a healthy pricing environment, as I've talked about. The one thing that the industry is facing and we are facing is a bit of an unwind out of the COVID era for '23. And a little bit in the second half of '22 where some of the SKUs that we were selling to support COVID testing, COVID vaccinations and protection from COVID are all unwinding, and we probably have a couple of hundred million dollars of revenue that comes out of our base in 2023 that we're facing. But putting that aside, you see some reflective growth dynamics for the year. So let me just quickly wrap up here. And if you could remember 4 things from what I talk about as potential investors in Avantor is one of the attractive markets we're serving. Again, life sciences, 70% of Avantor growing very, very nicely. The capabilities that we have, if you look at -- remember that puzzle chart I had the commercial footprint, the portfolio of 6 million SKUs, the physical capacity that we have to be near our customers and the acumen that we bring an expertise we bring in material sciences is unmatched. The track record of exceeding our guidance. We intend to continue with a hardcore focus on that long-term guidance and making sure we're we're tracking towards it. And then innovation. And whether it's through our customers' innovation, our own capacity expansion, we're excited about what that could mean. So let me leave it there. I want to -- for those of you who are our investors either in the room or listening, I would -- I thank you for your support. For those of you here not, there's still plenty of room on the Avantor train. I would love to have you a part of it. So thank you very much for your listening.