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

All right. Good morning, everyone. I'm Tejas Savant, and I'm on the life sciences sector here at Morgan Stanley. It's my pleasure today to host Avantor. And speaking on behalf of the company, we have Michael Stubblefield, as CEO. Thank you so much for joining us, Michael. Before we get started, important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, do reach out to our sales rep.

So Michael, maybe just to kick things off, '24 has been an eventful year for you, both in terms of the reorg you started at the end of last year, new leadership, a more conservative guidance philosophy, some portfolio shaping more recently as well and sluggish but improving end markets coming out of the pandemic. So just talk to us about how the year's played out so far versus your initial expectations?

Yes. Firstly, Tejas, thanks for having us. Really happy to be here today. It's good to see you all. I think it's a good place to start. I'd say at a high level, the year has, plus or minus, played out in line with our expectations. There are a lot of moving pieces. When I look at kind of the beginning of the year, we were obviously focused on launching our new operating model, which we announced back in December. And that has really brought about a completely different way to not only think about the business, but the way we run the business, focused on our customers' needs in both the lab and in the production environment. And I'm really happy with how that is playing out. You referenced some of the momentum that we're seeing in some of our end markets, probably highlighted by Bioprocessing. It has been good to see order book momentum over the last number of quarters now finally starting to translate into revenues. So that feels pretty good. In connection with our new operating model, we also announced a pretty significant cost transformation targeting $300 million of EBITDA synergies being delivered by the end of 2026, and that's going very, very well. We were fortunate to engineer a really great outcome for our Clinical Services business, which is going to accelerate some of our deleveraging and will improve our balance sheet, give us more flexibility going forward. So yes, I think we -- there's a lot to like about the setup for the year, and we're really focused on driving growth with our lab and production customers.

Got it. So let's start with BPS and specifically Bioprocessing, Michael. Despite some pockets of weakness, which we'll get to in a minute, you've notched up 3 consecutive quarters of sequential order rate improvement in Bioprocessing, and you increased the guide as well in the second quarter. Has that momentum in order trends continued coming out of the quarter? Is it sort of broad-based enough where you feel confident in the recovery in that end market?

So for us, Bioprocessing, as reported in our Bioproduction, our BPS segment is about 2/3 of the revenues in that segment. So it's obviously an important part of our business. And as we discussed on the second quarter call, we have been seeing momentum that started to build modestly in the fourth quarter, order book starting to improve. We saw that carry forward into Q1 and into Q2. And we're starting to also then see just given our lead times, which in that business about 2 to 3 months, we also started to see an uptick in orders now translating into revenues. And so to see that over 2 or 3 quarters and to now have a bit of an outlook into the second half of the year as that order book continues to build. In the second quarter, we did take up our outlook on a full year basis for that part of our business and would now estimate somewhere in the mid- to high single digit from an exit rate standpoint in the fourth quarter. So I think we feel really good about the momentum. There's still some room to run. Obviously, that platform over the long term, we'll run higher than that. But certainly, we like the direction we're traveling along.

Got it. MAbs remain the core driver of the business today, but can you talk about your positioning in some of the higher-growth modalities, such as cell and gene therapy, GLP-1s, mRNA. Where do you think Avantor is most underpenetrated and best positioned to grow? And outside of GLP-1s, has the ongoing sort of pipeline reprioritization that we hear from the CROs and some of the pharma guys been an issue for you at all?

So 1 of the things I really like about our Bioprocessing platform is just how relevant our technologies, whether it's our process ingredients, our excipients, our single-use platforms, how relevant they are across all of these modalities. We're obviously very well entrenched in the mAbs space, which is driving the bulk of the revenue for our industry. But similarly, we're also ubiquitous across all the other emerging modalities, which I think fuels our view on kind of the long-term health and outlook for this space. A lot of great pipeline candidates coming through in mAbs, which we think is going to continue to make that relevant for a long time. But a lot of approvals and momentum in cell and gene therapy, where we have some really good positions there. You mentioned GLP-1s, our process ingredients and single-use technologies are relevant there. It's obviously early innings. And I think as we look through that pipeline there, some of the next-generation technologies probably even use more of our content than the current generation. And so that's something that we're spending a lot of time on and watching carefully. MRNA is -- as we learn through the pandemic, is going to be an important modality longer term. And again, our content is extremely relevant there. And I think the collective experience of the value chain during the pandemic has probably pulled forward those pipelines by a number of years. So I think the setup for this space is incredibly healthy with strength in the core mAbs, but all these emerging modalities, I think just give us a lot of optimism just given our relevance across that entire continuum.

Got it. Just double taking a little bit on GLP-1 category, Michael. One of the questions we get is what exactly is your exposure there, both in terms of your portfolio, but more importantly, in the context of the Bioprocessing segment itself in terms of revenue? And there's been a bunch of really exciting label expansions for GLP-1 even relative to your Analyst Day last year. So has that sort of translated into an increasing proportion of Bioprocessing revenue from GLP-1s?

So as I said in the answer to your last question, it is a really exciting area. So obviously, getting a lot of headlines. And certainly, the promise of the science there is exciting and to see it extended into new indications is going to be helpful for the long-term trends there. The technology, I would say, kind of in Generation 1 here and from a tools perspective, there's more modest consumption of the content relative to say what we might find in mAbs. But as a materials and chemicals manufacturer and then a leader in that space, we probably have a bit more exposure into these current generations and maybe some others out there, and we're certainly benefiting from some of the tailwinds here. But as we look ahead at the candidates that are coming through the pipeline, second, third-generation technologies, then we'll see how this plays out. But those probably even have more content. So early innings, we're relevant. We're certainly well positioned here. And we think long term, this is going to be just another one of the exciting growth levers for Bioprocessing.

Got it. Switching to just the mix of the business. How much would be pharma biotech versus CDMOs? And do you anticipate any lumpiness in CDMO demand from either the BIOSECURE legislation or similar proposals or the recent consolidation in the space?

So we're going to be quite relevant and well positioned, as you would expect, in both the originator platforms as well as with CDMOs, both really important segments of our business. And in our business model, as a materials provider, we're going to be accessing these platforms in early phase discovery and earning that specification. And then we kind of follow the molecule. The OEM is going to set the specification. And of course, if they want the molecule produced at a CDMO, we're going to be present there. So we have really good exposure in relationships across both customer segments. And from a -- as the year has played out, we haven't really seen probably any different dynamics at least that are worth calling out in terms of CDMOs performing differently than what we might find with the originators. Both, I think, are seeing momentum, and we're well positioned to capture the growth at both.

In steady state, Michael, is there any reason why the Bioprocessing business can't grow almost better than low double digit? And as you think about your SKU there or the SKUs you offered there today, are there any obvious gaps in the portfolio that would make sense for you to fill in?

So when I think about our exposure to bioprocessing and if we kind of cut the experience here over the last several years, which have been really hyper growth followed by a reset coming out of the pandemic and look kind of on the other side of that, this is an end market that, on its own, has grown plus or minus double digits. And we have historically outgrown the broader market by 300 to 400 basis points in this space. So if you go back to the Analyst Day that you referenced earlier, is we're talking about our long-term algorithm of mid-single-digit growth at an enterprise level. That contemplates Bioprocessing growing low double digits to kind of mid-teens, which I think is pretty clear line of sight to how you get there. The mAbs space on its own is, on an end market basis, is plus or minus double-digit growth. And then we've talked about all these exciting new modalities that are coming in that will just be accretive to that. And so you come up with whatever your favorite assumptions are on those end markets. The end market itself for Bioprocessing is clearly, long term, going to be a double-digit grower. And we would tack on another 300, 400 basis points. Just given the relevance of our portfolio and our content, certainly having as much exposures we have to single use is helpful. Our global footprint that gives us access through our channel to be able to reach virtually every platform that's out there really underpins our conviction on that outlook. So yes, we'd agree with your view there -- that there -- this will be a strong growth driver for us over the long term.

So the power of BPS beyond Bioprocessing and Biomaterials and Advanced Technologies, Michael, about 1/3 of the business. On the NuSil piece, are you hearing any concerns from your medical device customers around just tougher utilization comps coming up or headwinds in China starting to weigh on demand?

So 1 of the things I really like about our new approach to operating the business and the new segmentation here as it does probably give a little bit better visibility into some of the other attractive platforms that we have in the portfolio. You're talking about our Biomaterials or some of you may know it as our NuSil platform, which is deeply embedded in the medical device space as well as in aerospace and defense with a really terrific offering here. This is one of the most unique businesses that I've come across in my career just in terms of the stickiness with the customer, the level of innovation that you're able to bring to bear here and the value you're able to capture associated with that offering. It's a really fun business to be part of. When we're extremely well positioned, so yes, we're -- certainly follow the developments closely in the medical device space. And fortunately, we're really diverse here. There's not -- probably hard to come up with an implantable device that wouldn't have some exposure -- that we wouldn't have some exposure to. And that's true across all the geographies. So really diverse platform at a really deep innovation pipeline. We would be working on upwards of 600 projects at any one time on all of the latest developments across this space, which -- the trends here are pretty exciting. So it's a platform we like an awful lot, and I'm pleased that with this new segmentation, we get a little bit better visibility for you into how that business is performing.

Got it. Let's move to Lab Solutions. You took down the guide there for LSS last quarter. Can you elaborate a bit on the drivers of the change? And what is the relative magnitude of each one in driving the cut?

Yes. So if we think about at a high level how our Lab segment runs, right, it's -- it's a really sophisticated model where we have inventory positioned around the world to be able to support really dynamic requirements from our customers. Most of what we do is going to come in into our systems electronically and we'll turn that around and get that to them within 24, 48 hours. So the forward visibility on that business is limited by this requirement of our customers that we kind of book and ship their orders. And so from a guidance or forecasting philosophy, what we have been doing is taking kind of current run rates and then extrapolating that forward through the number of business days in a particular period, how pricing is phasing in. And so coming into the year, we had essentially taken the Q4 run rates and extrapolated those forward into the year. And as we got into Q1, we had a little bit stronger performance on things like consumables and chemicals, where we're seeing some improvement and where we have continued to see improvement. But we did see a step down particularly in biopharma capital spending on equipment and instruments, which within our Lab segment is about 20% of our revenue, and it was down pretty meaningfully in the first quarter. Fortunately, we've seen that stabilize as we've moved through the year at those levels. So consistent with the approach that we've been taking to forecasting the business, really just trying to reflect in our updated outlook for the business, just the reality of what we've seen through the first half of the year and forecasting that forward. So not trying to bake in an anticipated recovery or some change or recovery of that equipment and instrument part of the portfolio. So based on that, it did cause a slight modification to the outlook on a full year basis, which we were fortunately able to offset by kind of a corresponding increase in the outlook for our Bioprocessing business, as we talked about earlier.

Got it. And so in terms of the 3Q versus 4Q phasing, Michael, is that essentially just a function of normal seasonality?

So yes, so again, going back to kind of how we guided the year, taking run rates, exiting the year and then trying to apply not only just kind of the nominal business days, which -- a business like this, which is a daily rate of sales type basis, given how much of it is consumables-focused, timing of known orders or how the pricing phases in. We also then applied to the normal seasonality that we see in a year. And if we go back kind of pre-COVID days, that's about a 49%-51% split. And so that's how we set up the year. That's been the assumption from the beginning. And that seasonality is really more attributable to how our Lab business runs. So we're kind of in that period now where coming out of kind of the summer vacation season is when you start to typically see the seasonality kick in. It's modest, right? It's 49-51 split, but that's the assumption based on kind of historical patterns. And as we talked about on the second quarter call, we don't have the visibility to know is it going to play out as it normally has or something different. But the ranges that we've given for the outlook for the year, we do think -- contemplate that. That if for some reason that this normal seasonality didn't materialize, we think we're well covered by the low end of the range. So I think we feel good about the outlook for the year.

Got it. Just double-clicking on the E&I weakness you called out, Michael. What does the order funnel look like? How has the time to conversion metric improved a little bit? And have the project reinitiations you flagged in things like electrical board design and manufacturing started to translate into RFPs yet?

Yes. So I'd say a couple of things. One, I talked earlier about the consumables and chemicals in the lab, kind of showing steady improvement as we've moved through the year. And in fact, those categories have returned to growth for us on a year-over-year basis, which is encouraging. And for me, that is also a signal of activity level in a lab. You can't be doing research without using those materials. So to see those turn back to growth, I think, is a really good sign for us. Now specific to the equipment and instrument, obviously, if you're trying to constrain or control cash flows and capital spend, you can optimize when you make those investments, if you're reprioritizing your pipeline and you're not outfitting new labs, you're certainly going to see a downturn in equipment and instruments. But going back to my views on the level of activity, we do see a very healthy pipeline and have seen all year actually a really healthy pipeline for new opportunities and projects for -- that will require equipment and instruments. And so our sales teams have actually been quite bullish all year despite kind of the underperformance and converting it to revenue. And it feels a little bit like what we saw last year on single use. If you remember, some of the leading indicators started to turn green, which had us a bit excited, but what we experienced was a little bit different cycle to see those leading indicators convert to orders. We're seeing the same dynamic play out on equipment and instruments that -- from quote -- or opportunity to quote to order cycle is being elongated. We've seen it stabilize as we've moved through the year here, but it is seemingly taking a bit longer for these projects to convert. But we're encouraged by not only the activity level and the pipeline, but the customer sentiment continues to be strong as well.

Got it. What does the pricing environment in the channel business look like, Michael?

Yes. So one of the important drivers of margin for us, of course, is how we manage this trade-off between price and COGS. And that has played out very much in line with what we would have anticipated coming into the year. We're getting our normal contribution to margins from that. Fortunately, coming off a number of years of kind of hyperinflation, which required well above historical price increases, we've been able to manage the business this year with more normalized levels of pricing, and it's been, I would say, pretty stable as we've moved through the year here.

Got it. So last month, you announced the divestiture of the Clinical Services portion of LSS. Not a huge business in terms of revenue contribution, it's about $200 million or so. Can you walk us through the strategic motivation for the divestiture? And more importantly, I think you've said in the past that Clinical Services margins are closer to your proprietary margins versus your third-party margin. So the timing, obviously, of the transaction closing is uncertain. But if you were to assume a December 31 close, what would the dilution be like next year?

Yes. This was kind of an exciting strategic move for us to be able to announce the divestiture of that business. And it was really enabled by the new operating model and the focus that comes from specifically aligning yourself with the needs of our customers in the lab on one hand and then with their needs in the production environment on the other hand. This particular asset -- and it's a collection of multiple assets that have actually been purchased well over a decade ago that had been integrated to reflect our offering in the clinical services was kind of in this middle ground that didn't really fit in lab or didn't fit in production, and it was certainly subscale relative to the marketplace. And so as we look at bringing focus and disciplined execution, we kind of flagged it as an opportunity. And fortunately, it is an attractive asset just in terms of the customers that it serves and being able to attach it to the clinical trial work. And so it was an asset that was very heavily bid, and we really like the outcome that we were able to engineer. Our intent from the timing of announcing that, to your point, it was a $200 million transaction that we covered just with a press release with the full intent that we'll get into more details on that on our third quarter call as we get a little bit closer and more certainty around the timing of the close here. So I think the cash generation here and the opportunity to retire some debt, improve the balance sheet, it's a really good outcome for the company as well as for our associates in the business to put it in hands that are probably going to be more willing to aggressively invest and grow that business.

Got it. And post the Clinical Services divestiture, Michael, is specialty procurement still something you have used quarterly offering? I mean you used to always talk about those 2 businesses in pairs in the past. So how do you think about that?

Yes. So it's a really important distinction to drive. So prior to the divestiture, services for Avantor were somewhere between 12%, 14% and 15% of our revenue, somewhere in that range depending on the quarter. And it was comprised of a number of core offerings. This Clinical Services piece was certainly a piece of that. You referenced the specialty procurement services that we provide. That stays behind because that's really critical to how we service our customers in the lab. And probably the biggest part of what we do from a services standpoint is something we call LPS. And this is the deployment of Avantor associates now well over 2,000. That -- where our badge and our uniform like show up and work at our customers' facilities in their laboratories doing a whole host of activities, including a lot of benchtop work for them. And so between the access we get to our customers through these associates together with the view into their material requirements that we see through this procurement arm, both really quite integral to our offering in the lab. So those will stay behind, and the divestiture only covers the clinical assets that we have.

Got it. Fair enough. On the biopharma end market, Michael, I just wanted to get your pulse check on more recent trends. On the global side, we've had some preclinical CROs talk about IRA and patent cliff concerns and some reprioritization of pipelines there. On the other hand, on the biotech funding side, I mean, while they've called out, I guess, a slower recovery, but improvement more recently, I mean, the focus is going to switch more to interest rate cuts and how that impacts the biotech landscape. So curious as to what you're hearing in your conversations with that customer base?

So I think our customers, whether it's patent cliffs or IRA, I mean I think they've had good visibility of that now for a few years. And when we started to see some of the slowdown within biopharma R&D, I think, is very closely linked to when some of this pipeline reprioritization started to occur last year. And so from our perspective, most of, I think, the impact has probably flushed its way through the system at this point from a pipeline standpoint and whether it was directly connected to our IRA or just a good opportunity for companies to kind of reprioritize and reposition their portfolios. The net effect was certainly a slowdown in early-stage activity in part due to the -- some of the funding constraints on biotech. And so as we've seen kind of that reprioritization activities start to moderate now and a return of the biotech funding, I think both of those will ultimately provide tailwinds to our business. And I think if we take it up a notch, ultimately, I guess, our view is good science is going to get funded. And when I look at these pipelines, some of these new modalities and the promise that underpins those various technologies and the promise that it provides for patients around the world, I think there's a lot to like about the long-term setup for this space.

Got it. Switching to academic and government. I think that's about 1/4 of LSS for you in terms of end market exposure. So walk us through the different pieces there. I mean Higher Ed is the largest piece, followed by K-12 and then, of course, the government piece, different dynamics for you. So just walk us through how that's -- those 3 niches there within academic and government are playing out relative to expectation?

Yes. So at the enterprise level, our exposure to academia and government is about 15% of our revenues, and that's -- probably 10-ish percent of that is going to be academia and the balance being government exposure. Over the long term, we would anticipate that this end market for us would grow kind of low single digits. And we've done -- it's been a bit lumpy over the most recent years, just given the government funding for a lot of the COVID response. And then we see that starting to normalize, and the government piece of this has been somewhat muted generally over time and ebbs and flows a bit. Higher Ed for us is a really strategic end market. The growth dynamics don't match what you might see in biopharma necessarily. But we like the space a lot because it's oftentimes a scientist's first exposure to our brands and our offering. And over the last number of years, we've seen a market pivot of their focus area into biopharma. And not just for the sake of interesting research, but with an eye towards commercialization. And so it's taken on an important -- more important prominence for us given that dynamic and the importance of getting our content seeded there so that if it does ever make its way towards commercialization, that we're part of that. And so we have deliberately doubled down on commercial intensity and coverage into this space, which historically we're probably a bit underrepresented here, to be fair. And that focus and that intensity has really paid dividends. We were growing above market in that space last year. And I think, again, this year, even with the difficult comparisons that we have, we're having another great year in the Higher Ed space.

Got it. Switching to the financials a little bit. You guided to mid-single-digit long-term organic growth at your Investor Day last year. Just given your comments on Bioprocessing set to exit the year in that mid- to high-single-digit range, relatively easy comps next year, especially in the first half. And an assumption around just that metered end market improvement as well. Is 5%-ish growth a fair base case scenario?

So when I look at the kind of how this year is playing out, which is plus or minus in line with our expectations, by the time we get to the fourth quarter and exiting the year, both of our segments will have returned to growth, still somewhat below kind of the long-term targets for both of those segments. But nevertheless, showing some momentum and turning into the green territory, as it were. So I think we're encouraged by the trajectory here and the momentum that we're seeing building in both parts of our business. Similar to how we've done in prior years, just given kind of the visibility that our business model gives us, we'll take the time to get through the year, through the fourth quarter, and we'll come forward with our thoughts on '25 as we get into the first quarter.

Got it. Fair enough. How are you thinking about upside versus the $75 million in cost savings you've identified this year? You saw some very meaningful upside to margins in the second quarter. I think it was more than 70 bps or so versus your own expectations. How much of that was pricing versus Bioprocessing mix versus cost up?

So a few things to unpack there. Firstly, in reference to the transformation savings, we were targeting $300 million by the time we're exiting '26, with an in-year impact in '24 of about $75 million. And we're still modeling it that way. But we've been, I think, pretty transparent through the first half of the year. We've been able to accelerate some of the savings and bring those forward. We even started to see some as early as in Q1. So I'm really, really happy with -- Brent is leading that for us and doing a really terrific job on executing that together with the organization. So I like the setup for that. And what that's enabled us to do, together with some of the recoveries we're seeing in Bioprocessing, which is helping us improve the mix of it as we move through the year. What -- together, what these have enabled us to do is to kind of flatten the ramp that had been implied by our margin guidance for the year. And so we like that set up and at least through the midpoint, we felt it was prudent to maintain it where it had been. Admittedly, though, significantly derisked from maybe where we were at coming into the year, just given the strong execution through the first half of the year. So we're driving as hard as we can and as prudently as we can on the transformation to deliver that program. And certainly, we're trying to accelerate where we can. We'll keep that in front of you. As we move through the quarter, we'll certainly have more to say about that on the third quarter, where we're at. And as we get further into the program, we can give you updates on the targets. But it's going very well. And I would say it's probably difficult to parse out the contribution from each of the levers that you mentioned. I think they're all certainly accretive. We talked a little bit about price over COGS working well for us this year. Certainly, the mix is an important part of our algorithm. And when Bioprocessing is starting to grow again, that really helps the mix and the margins that come with that and then, of course, good execution here on transformation. So margin certainly has been one of the bright spots for the story this year.

Got it. You've talked about exiting '25 at 20%-plus EBITDA margin. How should we think about upside to that number? I mean you've sounded really confident in margins the last couple of quarters, Michael, and it felt like it was more sort of controllables driving the margin expansion versus things beyond Avantor's direct control. So help us think about upside to those targets? And at a higher level, I mean just the operating leverage in the model, particularly on the bioproduction side of the business.

So 1 of the reasons why I think you hear a lot of conviction in this target of exiting next year at 20%-plus EBITDA margins is that we can get there largely through things that we can control. Having the aggressive cost transformation in play and the solid execution that we're seeing is showing up. You see it in the numbers. We're just a touch below 18% and well on our way to 20% by continuing to drive that program forward. There's lots of ways to get there. And certainly, we'll take any of the tailwinds that come from a market recovery. And the proof point coming from the second quarter here is as you start to see momentum in things like Bioprocessing, as I referenced earlier, the incrementals here are pretty significant. We're not having to add fixed costs to capture the incremental revenues that we're seeing. And it is certainly driving strong momentum on the margin line. So we don't need a strong recovery here to get our targets exiting next year. But certainly, if that were to come, we'd view that as a tailwind.

Got it. At what point does M&A become a priority again, Michael?

So for us, we're really committed to getting leverage below 3x. The divestment of the clinical assets will certainly help accelerate us by probably half a year at least. But our priority until we get there certainly remains debt paydown. And just to be clear, it's not a scenario of, oh, we're at 3, so let's take it back up to 4.5 with another big deal. We really do want to run in an envelope where 3 becomes the ceiling. So we need some help here on the EBITDA line to start to move the leverage ratio in the right direction. We're certainly generating a lot of cash. That's a really bright part of the story this year with year-to-date conversions well over 100%. So we're generating a lot of cash, making a lot of headway on the debt paydown. But we're going to need to get the EBITDA moving in the right direction before we can get to the levels that we're targeting.

Fair enough. Great place to leave it at. So thank you so much, Michael. I appreciate the time today.

Thank you. Thank you.