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

Perfect. Good morning, everyone. This is Rachel Vatnsdal from the Life Science Tools and Diagnostics team at JPMorgan. Thank you so much for joining us today. On stage, I've got the Avantor team. We're going to start off with your typical presentation around 20 minutes, and then we'll shift to Q&A. If any of you in the room have a question, I believe we have mic runners. You can also submit your questions on the app or ping me directly. So with that, Michael, I will hand it off to you for the presentation.

Great. Thank you, Rachel, and good morning, everyone. Thank you for joining us here to kick off the New Year at the JPMorgan Conference. Again, as you can see, I'm joined here on stage by our CFO, Brent Jones. Also in the audience, we have our Head of Investor Relations, Christina Jones; and Kitty Sahin, our Head of Corporate Strategy, is also with us today. I'm not going to read our standard disclaimer for you, but I would point out that we will be making forward-looking statements in our presentation today. And they're accurate as of today. And we will probably reference a number of non-GAAP measures throughout our presentation, and you can go to our website for the various definitions and reconciliations of those. All right. Let's jump in. Today, I hope to cover 5 key messages with you today. Firstly, I want to point out that we've established ourselves as a leader in a super attractive space. I talked in December at our Investor Day about the golden age of science and how there's never been a more exciting time to be serving science and particularly as a leading player in the life science tools space. Tools historically has outgrown the broader market by approximately 2x. And despite the headwinds that we faced as an industry over the last couple of years, I think the fundamentals are fully intact, and we think the outlook is bright. We're coming off a year with, I think, the second most number of FDA approvals, really rich pipelines and the future is indeed bright. We announced in December that we're transforming our operating model, which we think will help us accelerate growth as well as unlock significant productivity. We have a really attractive organic growth opportunity that we think is underpinned by some really exciting developments in various high-growth workflows that we're laser-focused on. And given the customer segments that we serve, driving growth through innovation is also extremely important to our model. We're going to spend a little bit of time sharing with you how we think about the financial setup for our business over the next several years and over the long term and we think that certainly in the next couple of years will be characterized by outsized recovery, and we think we've got a pretty compelling long-term value proposition as well. And hope to convey, lastly, my confidence in our setup for delivering on our long-term targets. So at Avantor, our model is rooted in serving our customers from discovery to production. And as a leading supplier of laboratory consumables as well as high-purity proprietary materials for bioprocessing and biomaterials, we're involved in our customers' most important research, scale-up and production activities in the industries that we serve. To the right on this slide highlights some of the important or critical attributes of our business model. Importantly, we have an overweight exposure to the biopharma and healthcare space where we derive more than 60% of our revenues. And importantly, our portfolio enables more than 85% of our revenues to be recurring. One of the reasons why I particularly like that makeup of our business is that if you look over a typical business cycle, consumables portfolios would outgrow equipment and instrument portfolios by 150 to 200 basis points. And not only is our revenue highly recurring, but it's also quite sticky. If I look at our proprietary products that are used in our customers' production processes, more than 90% of the revenue that we derive in those platforms is specified in and written into our customers' regulatory filings. And the entire model is underpinned by really deep, enduring customer relationships that have been fostered over decades through really intimate access that we have. We have a really rich offering of products and services that create a lot of value for our customers, but our value to our customers goes well beyond the products and services that we offer. We're an important partner to helping our customers meet their ESG goals and commitments that they've made, including many who have made net zero commitments. And in fact, they can't get there without us. And so we're squarely focused on embedding ESG practices across our business. We think it's good for society and it's also very good for our business. As you can see on the slide here, we announced new 2030 science-based climate targets that we're excited to embark on. And we received a lot of recognition over the last year or so from various third-party groups validating the progress that we're making in the other pillars of our ESG strategy. Lots to do in this area. We're certainly committed and we're really proud of the progress that we're making. So we've been around the business for almost a decade now, and we've been busy building a leading Fortune 500 life sciences company. It's been super fun, and we made a lot of progress. If I look at where we were at a decade ago compared to where we're at today, our bioproduction business, which is the hallmark or the key pillar of our growth strategy, looks completely different when I look at the capabilities we have, the footprint that we have, our innovation capabilities, our access to our customers. Our go-to-market model has evolved significantly. We've built out a world-class digital platform. And we've achieved a scale and a scope that's unparalleled. But we're not resting there. There's a lot more to do, and I'm really excited by the next phase of our evolution, which we announced in December with the announcement of our new operating model that went into effect with the turn of the calendar here. And what we did announce is that we're moving from a segment structure that was grounded in 3 geographic segments to 2 new customer-focused segments, a Laboratory Solutions segment and a Bioscience Production segment that leverage the strengths that we have serving our customers in the lab as well as in the production environment. These new segments build on the strengths that we have in serving those 2 platforms. I think it certainly makes it easier to understand our business. It will make our business more transparent, and it is my strong belief that it will focus our ability to grow in each of these segments, enhance our performance, and it unlocks significant operational efficiencies that I'll talk about here in a bit. And I think -- and one other thing, it ultimately positions us for a really attractive long-term growth profile. So let me talk a little bit about each of these 2 segments, hitting on Laboratory Solutions first. This will comprise roughly 2/3 of our revenue. And in this segment, this is going to cover all the activities that we drive in enabling our customers to generate precise analytical insights in their research, in their diagnostic workflows and also in their QC workflows. Our model here is grounded in a really comprehensive portfolio of consumables, both third-party as well as proprietary services as well as various equipment and instrument offerings. The pretty significant addressable market you see here of over $55 billion, and we expect this segment to grow low to mid-single digits over the long term. I really like this graphic because it depicts the deep customer access that we have in serving our customers in the laboratory environment. This is just a graphic of a typical campus at one of our biopharma accounts where you can see how pervasively we would service this customer. We even joke in creating the graphic to see all the cars in the parking lot. Those are probably also Avantor associates who are providing services in the various laboratories throughout our customers' campus. But you can see us here and would find us present in our customers' research labs, you'd find us in their process and product development facilities. You'd see us in their production facilities, providing a full set of custom materials. We'd be supporting their QA/QC workflows, and we even would partner with procurement to bring visibility to inventory and transactional efficiencies. So when I think about how our model really works, it's really rooted in how deeply we would service our customers and the unparalleled access that we do have. And this access and this scope and scale we've achieved makes us a leading partner for labs around the world. We're clearly a #1 or #2 player in each of the regions that we serve and we're relevant. There's not a relevant company that we don't participate with, both large and small. And I think that's one of the important parts to understand about our model is, yes, we're going to be partnered with the who's who of our space, but through some of the exclusive relationships that we have. We also have some meaningful ways to service the thousands of start-up companies around the world as well. We have a really comprehensive portfolio that allows us to provide comprehensive solutions to our customers. We have millions of SKUs. And given the integrated model that we run at Avantor, this bullet here in the middle that references our ability to supply GMP-grade materials in the lab is a really important detail to try to understand, because it enables our customers to innovate with our materials with confidence, knowing that the same quality system that they're using in the -- that covers the materials that are being supplied in the lab is the same quality system. That will underpin our supply to them as their therapy ultimately advances to production, creates significant confidence and efficiencies with our customers. Last thing I'd point out here, I kind of referenced it on the graphic, but we have more than 2,500 associates that show up wearing our uniform but provide services to our customers at their campuses around the world, really deeply embeds us in their workflows, gives us privileged access to the problems that they're working on and drive significant product pull-through. And then in this space, the digital solutions that we provide create significant efficiencies and allows us to scale our solutions. We benefit from serving really attractive end markets who, generally speaking, are rather resilient. There's also some really great science that's driving the momentum in each of these end markets. I tried to highlight some of those here. But when I think about the technology developments that are driving the work that our customers are doing, particularly in the biopharma space, we're truly in the age of bio processing, not only is -- monoclonals still continuing to advance, but you have a number of new advanced modalities that are driving a significant amount of activity. And with the insights that we're getting from the evolution of proteomics and cell biology and genomics, it's an exciting space with -- along growth trajectory. Outside of biopharma, there's also a lot of great high-growth workflows that we're focused on. And you see in some of the more advanced technology areas like PFAS testing and clean energy, you're certainly going to find our solutions and our teams partnering with our customers in those areas as well. Our other segment is our Bioscience Production segment. This is where our bioprocessing revenues will be captured as well as the work we do in our biomaterials space for medical implants as well as the custom formulations that we supply into the semiconductor space. It comprises about 1/3 of our revenue. But importantly, it comprises about 45% of our enterprise profitability. So it's a super important platform for our business. In this particular segment, regardless of the application that we're participating in, we would provide custom high-purity formulations that are specced into our customers' final production process. Typically, these would be in highly regulated applications with extremely stringent performance specifications. And our ability to innovate at scale is one of the things that really drives this particular platform. Our global quality system is critical in this environment, just given the sensitive nature of the applications that we're supporting, and our deep regulatory expertise helps us partner with our customers to accelerate them through the approval process. This particular platform, we seed the revenues from this platform by partnering with our customers in early phase research and development. We customize the solution and then we scale with it as our customers' platforms are ultimately commercialized. Most of the revenue here, if nearly all of it, is recurring in nature and nearly all of it is specced into our customers' process. I mentioned this is where our bio processing platform is housed and clearly drives the lion's share of the performance in this particular segment. As a leader -- leading materials provider to this space, we've created quite a niche for ourselves where we're the leading provider of process components, excipients as well as having the largest library and catalog of single-use components and one of the only end-to-end aseptic fluid management solutions in the industry, and we're extremely well positioned here. We're going to be pervasive across all modalities. We're going to be specced into more than 85% of the top 20 commercialized drugs, and we're going to be present across the pipelines. When I think about the growth drivers for our business, certainly, a big part of it comes from our positioning here in bioprocessing, where we think long term, we'll continue to grow this platform double digits and that you can nearly get there by just looking at our exposure into monoclonals, which we think will grow over the long term in and around that double-digit level. We're going to provide a pretty comprehensive material solution, both upstream, downstream as well as into fill finish. But importantly, we have significant exposure to the emerging modalities in things like cell and gene therapy, where there were more gene therapy approvals in 2023 in the last 5 years combined. We've all been following the GLP-1 trend pretty closely. And our technologies are going to be relevant, both in the fermentation route as well as in the chemical synthesis route with the various process ingredients and excipients buffers that we supply into those workflows. So we're agnostic to modality. We're agnostic to therapeutic area. And we're going to touch these molecules probably more intimately than anybody out there. We're encouraged by the deep pipelines that our customers are working on and the positioning that we have in those pipelines. Like I said, the -- we think this space for us will grow double digits. We've got a long track record. Certainly, the 10 years that I've been here, we've outgrown the broader market by 300 to 400 basis points. I don't see any reason why that won't continue. And not only is that being driven by continued strength in monoclonals, but we're coming off a year here where our gene therapy platform grew more than 30%. So if I think about the new operating model that we've announced and that we're in the process of standing up and implementing, there's probably 3 facets of that, that I would highlight. Firstly, we think that going forward, this new operating model will sharpen our focus on driving growth and margin expansion in both of our platforms. In a rather unique way, it unlocks significant productivity and opportunity to transform our cost base. And we think by splitting these 2 platforms based on our customer needs, we think it gives us the basis for really disciplined capital allocation to augment our organic growth strategy. When I think about driving growth on these 2 platforms, we think about a common growth framework for both pillars, although each of the segments will have their own unique organic growth strategy. But the common framework here would be the -- those 4 levers highlighted in blue in the middle of our slide here. There's a substantial existing base of business that offers really attractive growth features that needs to be nurtured and fed and invested in, in both platforms, and we're certainly prepared to do that. As I referenced before, both platforms have some high-growth opportunities and workflows that we're overweighting or over-indexing on, some of the new modality research, certainly some of the proteomic and genomic workflows in the lab as well as the new modalities that were supporting, whether that be GLP-1s or gene therapies, mRNA in our production platforms. Just given the science that our customers are driving, innovation is critical. And we've got a tremendous amount of work underway at our various R&D centers around the world. And even in the laboratory environment, we're an important funnel to the market for our third-party partners' innovations that help complete our workflows. Given the focus on these 2 unique customer segments, we think that aligning ourselves around these segments gives us an opportunity to more uniquely address the needs and provide a world-class customer experience for both of these segments. I mentioned our new operating model unlocking significant productivity and an opportunity to transform our cost base. We announced in December our plans to generate more than $300 million of gross cost savings that we would expect to be run rating at by the end of 2026. Brent is leading the way on this, and I've been really pleased to be partnering with him to put this in place. And you can see it is rooted in 4 key levers. Our new operating model does unlock significant organizational efficiencies. We've invested heavily in our footprint in various automation investments that we think enable us to optimize our footprint. Through the digital investments that we've made, we've got an opportunity to optimize our cost to serve. And both from a direct as well as indirect procurement perspective, we think there's significant savings that we can lean into there in the near term. So this is an important part of our financial algorithm here over the next few years. I mentioned the capital allocation focus that we have. And clearly, in this environment and where our leverage is at, we've been applying all of our available free cash flow to delever the business and to pay down debt. We've applied well more than $1 billion of cash to pay down debt over the last year or so. And we're focused on bringing our leverage under 3x. It's important to do that for a number of reasons, particularly in this environment, but I'm anxious to have a more balanced capital allocation strategy going forward, where we're not constantly bumping up against the ceiling of our targets. M&A is an important long-term value driver for our business. And at the right time, we'd anticipate getting back to deploying capital for that purpose. Just maybe a few thoughts around our financial model. I know that there's a lot of interest in how 2023 is finishing up and our thoughts on 2024. We're in the midst right now of closing the books on '23. We reconfirmed our guidance on '23 at our Investor Day in December, and it seems to have played out as we had anticipated. And we're on track to be able to provide you a fulsome view on 2024 outlook at our Q4 earnings call in February. When I think about then -- kind of over the -- maybe a midterm period might look like here on the left, we've talked about this recovery cycle, which -- it's difficult to be precise around the timing, but certainly, over the next couple of years, we would anticipate our P&L normalizing as destocking comes to an end, as the volumes return and we get the mix benefits, the leverage benefits of a more normalized environment to where -- by the end of 2025 or exiting 2025, I would guess that our P&L would look a lot like what it did back in 2021, which sets up then 2026 with EBITDA margins of north of 20%. And I think that then serves as a good jumping off point for at what point does our long-term financial targets kick in. And off of that recovered baseline, we would see an algorithm that would yield mid-single-digit growth on the top line, 50 to 100 basis points of ongoing EBITDA margin expansion, double-digit EPS growth. And this business generates a lot of cash. It's a capital-light model and our conversion rates are amongst the best in the industry, and we would anticipate free cash flow conversions of north of 90%. So before we turn it over to Q&A, just maybe quickly wrapping up here, I hope it's clear, my excitement and my conviction for this next chapter in our evolution. It's been an amazing ride. We built a leading platform, and we're just getting started. I'm convinced this new operating model will sharpen our focus on driving growth and productivity and unlocks significant opportunities to transform our cost base. And I think the industry fundamentals are starting to turn in our favor. The science, which ultimately drives the investments is as good as it's ever been. Our absence of exposure to China, the end or the nearing end of the destocking trends will certainly benefit our business. And this consumables-driven business model that we have will certainly lead to outsized performance here over the next couple of years as volume gets restored. It's the right operating model. It's the right strategy, and it's the right team to deliver strong value for all of our stakeholders over the long term. Thank you. I hope you enjoy the rest of your conference, and Rachel will now entertain your questions.

Perfect. Thank you, Michael. Maybe just to kick it off here, so your new long-term guidance calls for that mid-single-digit organic growth, 50 to 100 annual basis points of EBITDA margin expansion and then double-digit adjusted EPS growth. So can you walk us through some of the key assumptions behind that updated long-term guide? And then especially just given how dynamic the market has been the last 18 months, what gives you confidence post COVID that you're able to achieve these long-term growth rates?

Okay. So Rachel, I'll take that. So when you deconstruct the pieces of that, you start with the revenue growth. When you look at the lab sciences segment -- pardon me, when you look at the lab sciences segment, just the end markets, we have the entitlements in there very comfortably get you to low to mid-single-digit growth. You then heard Michael's comments on the [ BPT ] segment. Very comfortably, it can be at high single digits there. You blend that together. Just when you're looking at the end market entitlement, taking aside better execution, very comfortably get to mid-single digit as an enterprise. So you then move on the margin side. On the margin side, first off, we almost always take -- get price and applying it not just to the top line but into margin. Then the segments have differential growth rates. The BPT segment should grow higher, become a larger part of our business that has a better margin entitlement. That alone takes you a long way towards the 50 basis points. When volume starts working for us, we have very nice fixed-cost leverage in terms of how our network works there and then you add on to that ongoing productivity, very comfortable about that driving to 50 to 100 basis points. Then on the EPS growth side, just those, just mid-single-digit revenue growth, 50 basis points of margin, you're almost at double-digit EPS growth there. You then add the benefit of our deleveraging. For example, if we had the same -- even at a relatively low cost of debt capital, if we had the same deleveraging that we had in 2023, that would add about $0.04 to EPS. So you put that all together, very nice equation, lots of ways for us to get there.

Got it. That's helpful. Maybe just sticking on this topic at the Analyst Day, one of the key questions that we've been getting from investors was the -- surrounding the timeline of recovery that's embedded in that long-term guidance. So can you clarify for us on that timeline when you think the recovery period will begin? How long do you think it will last? And then ultimately, when could we exit this recovery period at which point you land at that 20% adjusted EBITDA margin?

Yes, hopefully, I was able to hit some of that in my prepared remarks. But first, I think when I look at the industry backdrop that we're shaping the year ahead, we think it's turning in our favor. As I mentioned before, we don't have China exposure, the destocking phenomenon or headwinds that have impacted both the lab side of our business as well as the production side of the business are nearing an end, if not already at an end for many of our customers. And the consumables focus that we have in our portfolio, we think, gives us a strong backdrop for the recovery to begin. It's difficult to be more precise about the timing, but certainly would anticipate our business to have normalized over the next 12 to 24 months, which means that exiting '25, we would expect our business to be fully back on track if we take the long end of that range, which sets us up then for, like I said, 2026 with EBITDA margins of north of 20%.

Great. Okay. That's helpful. And then I just wanted to touch on that $300 million of cost savings that you unveiled at the Analyst Day. How is that really embedded into this long-term guide? What portion of that $300 million will you see this year versus 2025 and 2026? And then you've talked about how you expect the majority of that $300 million to help you achieve your over 20% adjusted EBITDA margin by that exit rate on the recovery period. So what does that imply for those underlying core margins?

Okay. So there are about 8 questions there. So I'll unpack a bit of this. So $300 million gross, we expect there will be about $100 million of inflationary headwinds more broadly. So we expect to achieve $200 million net. Coming in 2024, we expect to get about 25% of the gross savings, i.e., about $75 million. Now we have indicated that we have meaningful headwinds there. And when you think about how 2024 should lay out, the headwinds that we have are very direct and are not phased. We have an incentive comp reset. We have merit inflation or otherwise. Now we have talked about inflation, we will face that in cost of goods. We expect to offset that with price. So this is just on an SG&A basis. So that's why when people ask us about the phasing of the cost headwinds versus the productivity -- so being that the headwinds will be consistent through the year and the cost savings will phase in, that should lead to an uptrend during the year in margin. That will be tougher at the beginning, be better in the back end of it. We expect to have the full $300 million -- we've only really guided the timing of the savings or discussed the timing of the savings for '24. The phasing of '25 and '26, we'll talk about more, and we expect to exit on that basis at the end of '26 with the full gross, $300 million. In terms of underwriting against the recovery, it's obviously a challenging environment, and we want to provide as much clarity. If this business -- Michael made the comment to being like 2021, if we get that kind of mix in the top line, if we get the right kind of volume, the business would want to do that. Otherwise, what this is, is the comments we made on making guidance. Being prudent, putting ourselves in a position to have the real confidence to underwrite the 20% when we exit the period. I don't know if you want to supplement.

Perfect. Maybe just while we're speaking on 2024, you've had a few of your peers lay out expectations for underlying market growth for the year. I appreciate you're going to give us formal guidance during 4Q earnings. But at a high level, how are you thinking about market growth assumptions? And then just on that top line for Avantor, is it possible for Avantor to grow in 2024, given what we're seeing in the market right now?

Yes. Certainly, Rachel, I can appreciate the intense focus on trying to unpack what the top line will do in 2024. And as you can expect, that will be an important part of our guidance that we come forward with in February. A lot of moving pieces, whether it's pricing, destocking, volume recoveries that we're working through. So probably at this stage, not -- probably not best or prudent to get ahead of our process. We'll be back to you more on that in February.

Fair enough. Maybe just circling back on margins for 2024. You said at the Analyst Day to really expect that 2024 adjusted EBITDA margins will be similar to the back half of 2023. That really implies high 17%. So given The Street is at 18.6% on adjusted EBITDA margins for 2024, can you walk us through some of the puts and takes on that margin line?

Sure. And it's sort of jumping on my other answer there. So if we enter the year being very much like the second half of this year, we then have the immediate headwinds of incentive comp reset, other merit in that. When you -- we do have the cost programs, we don't expect they're going to fully offset the inflation we see in the year. So there are a lot of moving pieces in all this, but when you do that math, you can see the differential in the margin rate. And then I would caution you, these are thoughts that we had on assuming no significant growth in the environment. We are not giving a guide on this. And even focusing on these little pieces is sort of taking a partial derivative about the year, not talking about mix and anything else, I would say, to be a theme we've had. Let's wait for the '24 guide, but those are the broad dynamics.

Maybe just as a follow-up, just on the pacing from 4Q to 1Q, given some of these headwinds that you noted, like stock-based comp and everything that expects to kind of comeback January 1, and pairing that with some of the cost savings that you've highlighted out of the cost savings plan. How should we think about the sequential margin progression from 4Q to 1Q? Should it be a step down, how meaningful?