Summary
- Thermo Fisher's share price has increased by more than 60% since the March lows.
- Despite a good free cash flow result in H1, the valuation is perhaps getting a bit ahead of itself.
- Trading at a current free cash flow yield of around 3%, I am not chasing the stock here but am hoping for a strong pullback.
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Introduction
Since my previous article on Thermo Fisher (TMO) in February, the company’s share price was only mildly impacted by the COVID-19 outbreak, and I never had the chance to initiate a long position at bargain prices. At this point, the company is already trading again at about 65% above its March lows, and I wanted to check if this share price surge is sustainable from a fundamental perspective.
Data by YChartsA strong operating cash flow leads to a substantial amount of free cash flow
Looking at the recently published financial results, Thermo Fisher had a very strong second quarter as its revenue increased by 10% while the adjusted EPS was boosted to almost $4/share (the adjustment is predominantly related to the amortization of the acquisition-related intangible assets). The strong revenue increase was predominantly caused by a $1.3B revenue boost related to COVID-19. While that’s great, this also means the non-COVID related revenue was also hit, in line with the expectations.
During the second quarter, the revenue indeed did increase to $6.92B, but as you can see in the image below, the operating margin decreased from 23.7% to 20.1%. That sounds problematic, but this is actually entirely caused by a small restructuring expense of $12M compared to a $484M gain recorded in Q2 last year. Excluding that one-time gain in 2019, the operating margin would have been just over 16%. So although the quarterly income statement of Thermo doesn’t look too fantastic compared to Q2 2019, keep in mind the non-recurring items had a huge impact in 2019.
Source: financial statements
Looking at the EPS in the first semester ($4.91/share reported, $6.83/share on an adjusted basis), Thermo Fisher appears to be a little bit ahead of itself considering it is trading at in excess of 25 times its annualized adjusted net income at the current levels.
