Life Science Toolmakers Help Ideas Become Drugs While Reinforcing Their Moats

Life science toolmakers that enable drug production operate attractive businesses for two major reasons that investors often find compelling. First, regulation of the drug manufacturing process creates highly durable switching costs for end users and long potential revenue streams for life science toolmakers. Second, life science firms often benefit from broad exposure to biopharmaceutical growth without taking on much product-specific risk.

Those two positive attributes caused us to lower our cost of equity assumptions on Agilent, Danaher, and Waters to a below average level of 7.5%, which is in line with its key peers in this space that we cover, such as Merck KGaA MRK, the Sartorius companies, and Thermo Fisher. That change in our cost of equity assumption was the major reason why we just increased our fair value estimates on Agilent, Danaher, and Waters in the 10%-20% range in conjunction with our recent research on the drug production process.

The durability and diversity of these life science businesses often do not come cheap from a stock valuation standpoint, but after the pandemic boom years, life science financial results started resetting in late 2022, causing shares to drop from recent peaks to reasonable, if not deeply discounted, levels. Currently, we think shares are suffering from market myopia during the 2023 reset. However, as profit growth normalizes in late 2023 and beyond, shares may eventually reverse course from their largely negative trajectories since 2021, and we recognize some growth at a reasonable price opportunities for long-term investors in companies like Agilent, Illumina, Sartorius Stedim, and Waters.