Under-the-Radar Stock Stuns on 1 Key Metric

When you see a Board authorize an aggressive share buyback, it should flash an alert signal to pay close attention to what’s going on at the company. That’s the case with Waters Corporation (NYSE:WAT), a stock that Al Gore’s Generation Investment Management now has a $388 million stake in.

That’s no mean position for a fund that, in many respects, is inspired by Berkshire Hathaway’s investment philosophy, albeit with a sustainability overlay. Generation would not buy Coca Cola (NYSE:KO), for example, as Buffett has because of the potentially negative effects of sugar when consumed en masse.

As a healthcare business, Waters falls into a different category of investment cases, one that is designed to benefit humanity. But that alone won’t cause it to blip on the screen of analysts over at Generation’s London headquarters. It must have a lot more going for it, so what are those factors?

What Makes Waters So Intriguing?

Waters flies under the radars of many a retail investor yet it enjoys a global presence that has operations in 35 countries and products in over 100, which combine to produce a highly diversified revenue base.

Thanks to its international wingspan, Waters is a stalwart financially with a history of consistent revenue growth and disciplined capital allocation. For example, over the past twelve quarters, just one was reported by management to have negative year-over-year top line growth.

The company’s revenue stability also stems from its aftermarket business that comprises consumables, services, and software. Together those areas produce a significant portion of the company’s revenue and, importantly, ensures steady and abundant cash flows.

Over the past three years, levered free cash flows typically oscillated between $150 and $200 million per quarter, with the most recent quarter being the rare exception that fell into the red.

For a company as large as Waters, featuring a market capitalization of $14 billion, it has also demonstrated impressive flexibility in its business model. When the pandemic hit, Waters was able to adapt swiftly and re-align resources to support research, vaccine development and diagnostics. Management’s agility speaks highly of its capacity to pivot well to new market demands in the face of challenging circumstances.

1 Key Metric Stands Out 

There is a lot to like about Waters but one financial ratio stands taller than the rest, return on invested capital or ROIC.

Waters’ ROIC is an astonishing 27.8%, a figure so high it should capture investors’ attention. That’s because, over the long-term, return on invested capital tends to emulate the cost of capital for a firm, and for the market as a whole is closer to 10%. 

Another way to think about ROIC is that the longer you hold a position, the more your returns should converge on ROIC. Of course, there are lots of caveats to that statement but it’s a decent rule of thumb and so any serious investor has to be impressed by the figure and wonder whether Waters can sustain it.

Notably, Waters has carved out a significant economic moat thanks to its specialization in liquid chromatography, mass spectrometry, and thermal analysis, tools needed for quality control in pharmaceuticals and biotechnology.

The company’s margin growth is insightful in Waters ability to maintain a high ROIC given that it has historically shown consistent operating margins. Gross profit margin has been just shy of 60% for the past twelve quarters and operating income has been in the black for every single one of those quarters.

A further reason to have faith in the firm’s ability to sustain a high ROIC is its prudent capital allocation, ensuring that investments are strategically directed towards areas that maximize returns.

Finally, management has clearly demonstrated a skill at forging strategic partnerships and making smart acquisitions, such as its acquisition of Wyatt, that cement its market position.

So, with all that said, is WAT a buy?

Is Waters Stock Undervalued?

Waters has a lot going for it from an abundance of cash flows to a stock that trades with relatively low volatility. Management’s aggressive buyback of shares and the company’s high return on assets are further supporting reasons to get excited by it.

On the flip-side, seven analysts have negatively revised their earnings forecasts for the upcoming period and revenue growth has been slowing recently.

Weighing up the pros and cons, is Waters stock undervalued? Waters is 18.2% undervalued according to the consensus forecast of 17 analysts, who have a price target of $289.18 per share on the company.

Running a discounted cash flow forecast analysis reveals a more modest 4.5% upside opportunity to fair value of $256 per share.

Is Waters Stock a Buy, Sell or Hold?

Al Gore’s fund, Generation Investment Management, added over 1.4 million shares of Waters as reported by its most recent filing. That places the company just outside its top 20 holdings, but still representing a significant $388 million position.

It’s easy on the one hand to see why the purchase was made. After all, Waters has had a pretty rough 2023, falling by 29.1% year-to-date. 

On a valuation basis, the stock appears compelling now, and particularly when viewed through the lens of analysts, who collectively have placed a price target on the stock that is over 18% higher.

With that said, revenue growth hasn’t exactly stunned over the past decade, rising from $1.9 billion in 2013 to $2.9 billion in the last fiscal year.

The attraction appears to be clear, though, Waters has carved out a niche that has produced an economic moat that is growing over time.

In turn that should boost cash flows and make the more sustainable and predictable over the long-term. Where Gore’s fund appears confident is the long-term returns, even if the short-term price action is indicative of market disappointment with slowing revenues.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.