Near-Term Biopharma Uncertainty Does Not Change Agilent's Long-Term Prospects

Senior Equity Analyst

Julie Utterback

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Life Sciences and Applied Markets Group

Diagnostics and Genomics Group

Agilent CrossLab Group

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After Agilent was spun out from Hewlett Packard in 1999 and divested its electronic measurement business (Keysight Technologies) in November 2014, Agilent focuses on providing tools to analyze the structural properties of various chemicals, molecules, and cells. Agilent is one of the leading providers of chromatography and mass spectrometry tools, which have applications in a variety of end markets, including the healthcare, chemical, food, and environmental fields. While healthcare-related applications, including clinical diagnostics, remain Agilent’s largest end market, Agilent generates about half of its sales from nonhealthcare fields. 

Agilent's strategy revolves around placing analytical instruments and informatics with relevant customers and then providing related services and consumables such as chromatography columns and sample preparation tools, which account for the rest of Agilent's sales. About half of Agilent's sales recur naturally. However, even instrument sales can be relatively sticky at the end of the instrument's life cycle, especially in the highly regulated pharmaceutical end market (over 35% of Agilent’s sales) and some of its other applications where intensive, time-consuming training is required to master the scientific analysis. Agilent aims to increase its exposure to these sticky customer relationships. 

Overall, we think top-tier positions in most end markets, innovation, marketing operations, and ongoing cost controls should help Agilent grow revenue in the midsingle digits compounded annually and boost margins overall during our five-year forecast period. Overall, we expect high-single-digit earnings growth from Agilent, organically and with some share repurchases. While internal growth opportunities look solid, acquisitions could add to its bottom-line growth prospects, as well.

Business Strategy & Outlook

We believe a wide moat surrounds Agilent’s analytical instrument business, consisting primarily of chromatography (gas and liquid), mass spectrometry, and other testing tools. Intellectual property and ongoing innovation create an intangible asset moat source while regulatory and reproducibility factors contribute to switching costs for end users. Both moat sources are crucial to Agilent’s ongoing advantages in its target markets, and with these advantages, Agilent enjoys strong returns on invested capital including goodwill of more than double its capital costs, by our calculations. 

Agilent offers differentiated technology that is protected by various intangible assets, including patents, copyrights, and trademarks. This portfolio of intellectual property and its innovation prowess in chosen fields keep competitors from directly copying its technology. Since even slightly differentiated technical features can cause an end user to prefer one tool over another similar tool in Agilent’s precise scientific end markets, we see intangible assets around its differentiated technology as a significant moat source. The differentiated properties of Agilent’s tools affect the performance, accuracy, and speed of the various research projects they enable, and differentiated product features create intangible assets that inform decisions to use those tools in specific applications, particularly at the beginning of a project. In order to remain relevant to scientists in early project phases, Agilent must continue to innovate, and that ability to innovate contributes to its intangible assets in this business, as well. Agilent has significant incentive to innovate since new products contribute to positive mix benefits, although it enjoys some like-for-like pricing power as well. 

After the initial choice of tools based primarily on intangible assets, Agilent benefits from substantial switching costs in most of its end markets. For example, over 35% of Agilent’s revenue is generated from the development and manufacturing of biopharmaceuticals, which is an extremely sticky business. In this end market, Agilent’s analytical tools are critical components of the production methods for various drugs, which are specified directly in each molecule’s regulatory approval application. Regulators require the same production method throughout a drug’s lifecycle, and any changes to the manufacturing process, including the quality assurance and quality control tests often performed on Agilent’s tools, would require approval from regulators. Regulatory requirements and reproducibility concerns, including employee training and learning curves, create switching costs for biopharmaceutical customers, which results in a very long potential benefit period for Agilent in this highly regulated market. For branded small molecules, that period can last up to 20 years from discovery until patent expiration. For large molecules (or biologics), that period can last even longer due to the difficult manufacturing process. Also, once a drug’s key patents expire, generic manufacturers often seek to utilize the same production methods that were used by the branded manufacturer to reduce product variability, and that adoption by generic manufacturers can create an even longer benefit period for Agilent on a specific molecule. 

We see narrower, but still strong, moats around Agilent’s analytical instruments that are used in other less regulated end markets--including chemical, advanced materials, food, environmental, and other research applications that represent nearly half of Agilent’s sales--and intangible assets and switching costs support Agilent's moat in most of those end markets, as well. Importantly, Agilent leads the market in gas chromatography tools that are often used in its less regulated end markets. Agilent generates more than double the revenue of its closest peer in gas chromatography products, and we believe its differentiated technology, strong reputation, and innovative capabilities create an intangible asset advantage in gas chromatography in particular. Also, Agilent’s gas chromatography instruments have a very long useful life around 10 years, and that long life contributes to the durability of its economic profits even outside the highly regulated biopharmaceutical end market. Specifically, while a customer uses these tools, Agilent should generate recurring consumable and service revenue, but we also believe other switching costs persist due to training and workflow productivity concerns for end users in these highly specialized applications. As scientists and technicians travel up the learning curve on new instruments, testing reproducibility and consistency may suffer, so end users probably would need a very significant technology improvement to induce them to switch providers at the end of a tool’s useful life. Overall, we think intangible asset and switching cost advantages associated with its highly specialized analytical instruments create the very stable market shares that Agilent enjoys even in these less-regulated end markets. 

Agilent’s remaining diagnostics business also has advantages with intangible assets associated with its differentiated testing platforms as the primary moat source along with some switching costs. In this division, Agilent’s tools primarily help clinicians diagnose and then develop therapeutic plans for patients with a concentration in oncology indications. Through its 2012 acquisition of Dako, Agilent enjoys a top-tier position in the anatomical pathology market for tissue-based cancer diagnostics, making it a major player with top-tier diagnostic firms Roche and Danaher. The company’s installed instrument base in this business and related consumable sales make this a decent specialty segment where pathologists perform sophisticated and time-consuming tests relative to the broader diagnostics market. However, this end market could come under some pressure in the intermediate term primarily as liquid biopsies emerge that could reduce false-positive rates (and related tissue biopsies) in individual cancer screening indications (like colorectal and breast cancer), which represents a moderate threat for the company. Agilent also operates in the companion diagnostic tool market where it makes consumable tests to help physicians tailor therapeutic options to their patients, and it provides sample preparation tools for the important next generation sequencing market. Overall, we think this division’s solid growth prospects combined with intangible assets and the switching costs associated with its large installed base contribute to Agilent’s maintainable competitive advantages. 

From an environmental, social, and governance perspective, Agilent faces limited risks that would not affect our wide moat view of the firm. Also, it is one of the few companies in healthcare that could benefit from ESG-related efforts to exercise quality controls on the products humans ingest, such as food, water, and pharmaceuticals.

Wide

Economic Moat

Agilent Technologies

Agilent Technologies, Inc. engages in the provision of application focused solutions for life sciences, diagnostics, and applied chemical markets. It operates through the following segments: Life Sciences and Applied Markets, Diagnostics and Genomics, and Agilent CrossLab. The Life Sciences and Applied Markets segment offers application-focused solutions that include instruments and software that identify, quantify, and analyze the physical and biological properties of substances and products, as well as the clinical and life sciences research areas to interrogate samples at the molecular and cellular level. The Diagnostics and Genomics segment consists of activity providing active pharmaceutical ingredients for oligo-based therapeutics, as well as solutions that include reagents, instruments, software and consumables. The Agilent CrossLab segment includes startup, operational, training and compliance support, software as a service, and asset management and consultative services. The company was founded in May 1999 and is headquartered in Santa Clara, CA.

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Earnings data Q2 2024

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