Waters Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Waters Corporation is a global leader in analytical instruments, software, and services, focusing on high-performance liquid chromatography (HPLC), mass spectrometry, and related technologies, primarily serving the pharmaceutical, industrial, and environmental sectors.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Waters Corporation (WAT) operates as a global leader in analytical instruments, software, and services. It provides high-performance liquid chromatography (HPLC), mass spectrometry, and related products to a wide range of industries. Their primary customers are in the pharmaceutical, industrial, material sciences, and environmental sectors. This deep understanding of their clients industries allows them to provide tailored solutions and maintain high customer retention.

Business Overview

Waters’ business is structured around three main pillars:

  1. Waters Analytical Instruments: This segment provides a range of high-performance analytical instruments, including LC, MS, and mass spectrometry systems. These instruments are used to separate, identify, and quantify the chemical components of samples. This is the core of Waters’ business, and they are the market leader in the field.
  2. Waters Software and Informatics: This division focuses on the sale of software products and solutions that help laboratories optimize their workflow, improve data management, and ensure regulatory compliance. This segment includes their flagship software, Empower Chromatography Data System.
  3. Waters Services: This segment provides various services, such as installation, training, maintenance, and consultation. They also supply consumables, spare parts, and other support products. Recurring revenue from these services contributes to the company’s stability and predictability. This also creates significant switching costs, a moat for the company.

The company’s operations are global, with significant presence in the United States, Europe, and Asia.

The analytical instrument industry is characterized by:

  • High Barriers to Entry: The research and development, manufacturing, and distribution of analytical instruments require substantial capital, expertise, and regulatory approval. This creates a barrier that favors larger players like Waters.
  • Technological Innovation: The industry is constantly evolving, with new technologies such as AI and machine learning being integrated into instruments and software to improve performance and data analysis. This means companies are in constant pursuit of innovation and improving their products.
  • Customer Loyalty: Labs often stick with a specific vendor due to the complexity of the instruments, the cost of retraining employees, and the risk of switching to another system. This creates switching costs for established players and can be a hurdle for new entrants.
  • Consolidation: The industry is consolidating, with larger players acquiring smaller companies to expand their product lines and market share. This consolidates the industry and creates fewer competitors.

Key competitors include Agilent Technologies, Thermo Fisher Scientific, and PerkinElmer. Waters’ ability to retain its leadership depends on continuous innovation and strong customer relationships. They do this through high-quality, specialized instruments and services to niche and big market industries.

What Makes Waters Different?

Waters has several characteristics that makes it different from competitors and helps it maintain their position in the market:

  • Focus on Liquid Chromatography: Waters is the recognized leader and inventor of liquid chromatography. They have focused on it and have been doing it for over 60 years. This gives them a specific edge in terms of experience and technology for their instruments.
  • Strong Customer Relationships: Waters emphasizes the quality and reliability of its products, building tight bonds with their customers and generating long term repeat revenue.
  • Recurring Revenue: Their diverse range of products and high customer retention is a major strength, because it offers consistent financial stability. Recurring revenue also mitigates risk and allows for more investment into research.
  • High Switching Costs: Because integrating into client businesses is essential for them, and also because of retraining costs and monetary costs, it is very unlikely clients would switch to a competitor.
  • Proprietary Software: Waters’ empower software is key to data management and workflow optimization, offering significant switching costs to users that already use the software, which is a lot of people.

Financial Analysis

Waters’ financials show the following characteristics:

  • Revenue Trends: Waters has continued to increase revenue from their products in their latest earnings reports with a slight drop in service sales. They are still growing, with an organic growth of 5.2% in Q2 2023.

In the first half of 2023 the pharmaceutical sector has been down and has impacted the growth but management expects this to improve in the following half.

  • Profitability: Waters is a profitable company, but their margins fluctuate. Gross margins were 57.4% in the most recent quarter which is slightly lower than the 58.6% in the previous quarter. Their operating margin for the quarter was around 28% which is higher than 26% in the previous quarter.

Their margins are generally strong, indicating their ability to maintain pricing power and leverage scale. The company has done a very good job at containing inflation, which has been a headwind on most companies lately.

  • Cash Flows: Waters generates solid free cash flows, which are used for expansion, share buybacks, and dividend payouts. They have a strong track record for consistent and positive cash flow for over 10 years.

Free cash flow was $178 million in the recent quarter compared to $114 million in the same quarter in the past year.

  • Debt and Capital Structure: Waters generally has a low-to-moderate debt level and a healthy debt-to-equity ratio. This provides them with financial stability and flexibility for future investments. They had $500 million in total long-term debt with total assets of $4.5 billion and total liabilities of $1.7billion, as of September 30, 2023.
  • Share Repurchases In the most recent earnings call the management talked about their share repurchase authorization, and reiterated their commitment to return capital to shareholders.
  • Dividend: Waters has been paying a dividend and has been steadily increasing it every year.

In their most recent 10Q report, the company has included a footnote about changes in accounting principle, that has affected their pension accounting. The recent FASB rule will force companies to recognize previously unrecorded pension liabilities. This could be significant for Waters and other companies, and can affect the debt level negatively.

Moat Assessment: 3/5

Waters possesses a narrow moat. The moat is derived from the following sources:

  1. Switching Costs: The cost and complexity associated with switching to a new system of analytical instruments is a major moat source.
  2. Intangible Assets: A recognized brand name, and a long history of innovation and research have established Waters as the leader in the market.
  3. Economies of Scale: Waters has a large customer base that can provide repeat recurring revenue, reducing some of the risks of a cyclical industry.

It is not a wide moat since, a new company can have a good product at a lower price, which will eat into their market share in the long term. The ability to maintain high client retention, and generate higher and more secure ROIC because of it is a great advantage they have that creates more value than their competitors that don’t have a moat.

Risks to the Moat and Business Resilience

Waters faces several risks that could erode its moat and impact its business resilience:

  1. Technological Disruption: The rapid pace of innovation can quickly displace established technologies or lower their price. Waters must continue to invest in R&D to stay ahead of potential new threats.
  2. Increased Competition: While barriers to entry are high, large or new competitors may be able to penetrate the market and reduce Waters’ market share through innovations and aggressive pricing. The increasing competition from new entrants could also lower their margins.
  3. Economic Downturns: The business is susceptible to downturns in the global economy and their R&D may suffer in recessionary times, reducing their ability to innovate and compete.
  4. Dependence on Pharmaceuticals: A considerable part of their business relies on the pharmaceutical industry. Any slowdown in this sector will impact their sales and profits, as reflected in the recent drop in revenue of this segment in 2023.

However, the company’s diversified base of customer industries minimizes the risks from dependency on a single industry. Despite these risks, the company’s recurring revenue provides stability and mitigates the effects of economic fluctuations, offering resilience to their business model.

Understandability: 2 / 5

Waters is a complex business due to the technical nature of their instruments and the diverse range of industries they serve. While the basic business model is straightforward, understanding the underlying science, technology, and accounting for all of their income is quite difficult. The complex financial statements and the amount of data that needs to be processed, makes it extremely complex to understand. A high level understanding is easy, but a deep dive requires extensive knowledge. It’s also an “enterprise business” that does not sell its products to retail clients, which can make it much harder to evaluate as well.

Balance Sheet Health: 4 / 5

Waters’ balance sheet is in generally good health with consistent positive free cash flow, moderate debt levels, and good liquidity. Their ability to pay down debt shows that they are conservative with how they finance their operations. While their pension liabilities are a point of concern because of recent accounting changes, their overall financial position remains strong and stable. Therefore, the business is not in any near-term danger in terms of solvency. However, that point might drop it down to 3/5 at times.