Waters Corp.: Embedded Expectations High Under Present Conditions

Core View - The stock of Waters Corporation (NYSE:WAT) has increased by 24% and is trading near the price objective of $340/share, with the company valued at approximately $19.8 billion [4] - The outlook has been revised to a hold due to the stock trading at around 22x forward earnings, which is considered fair value [4] - Key concerns include widening days sales outstanding, slowing instrument replacement times, and a cautious sales guidance revision [4][5] Financial Performance - Q2 FY'24 sales declined by 400 basis points year-over-year but improved by 500 basis points sequentially, with China being a significant drag on performance [5] - Management has revised FY24 sales guidance lower, projecting a decline of 0.5% to 2%, while earnings per share are expected to be flat year-over-year at $11.65 at the upper end [5] - Free cash flow for Q2 was $143 million, representing 28% of sales, and year-to-date free cash flow is $377 million [5] Regional Insights - Sales in China declined in the low teens year-over-year, affecting various sectors, while sequential upsides were noted in pharmaceutical and industrial markets [6] - Total Asia sales, including China, were down 300 basis points year-over-year, with the Americas and Europe experiencing steeper declines of 700 basis points each [7] Operational Metrics - The instruments business saw a 17% decline year-over-year due to reduced customer capital expenditures and delays in large equipment purchases [7] - Management expects normalization in trends, particularly in China, but evidence is needed to support this [8] Return on Capital - Waters Corporation has maintained high returns on capital, exceeding 20%, but there are concerns about potential declines in return on invested capital (ROIC) [4][10] - The competitive advantage period has reduced to 15 years, with a fade rate in ROIC increasing to 6.3% [10] Valuation Insights - The company currently trades at approximately 6.5x enterprise value to invested capital (EV/IC), which may contract further due to declining ROICs [16] - The market value added suggests that every $1 invested is currently valued at $6.50, which may not be sustainable [16][18] - Future earnings growth expectations are high, requiring significant performance to justify current valuations [23]