(TMO) Thermo Fisher Scientific Shares Maintained at Neutral

Recently, we reiterated our Neutral recommendation on Thermo Fisher Scientific (TMO) with a target price of $47.00.

Thermo Fisher continues to be focused on effectively deploying its cash balance to create value through share buybacks and suitable acquisitions. Significant acquisitions include that of Dionex Corporation and Phadia. The former brings in ion and liquid chromatography portfolio while the latter is a leading player in allergy and autoimmunity diagnostics.

Thermo Fisher is actively focused on improving its operating margin. The initiatives include adoption of Practical Process Improvement (PPI) and PPI-Lean projects, continued tight cost control on discretionary spending and infrastructure optimization that includes reduced footprint and expanded low-cost region (LCR) manufacturing (China, Mexico and Eastern Europe).

Of Thermo Fisher’s four end markets – Industrial/Applied, Biopharma, Healthcare and Government/Academic – the company has been witnessing increasing headwinds in the government and academic markets. Moreover, governments in the US and Europe are focused on reducing fiscal deficits and at the same time confronting slower economic growth. These headwinds forced the company to lower its outlook for the current fiscal.

In response to more challenging market conditions, Thermo Fisher undertook incremental restructuring actions and discretionary cost control during the quarter that resulted in $30 million of annualized benefit over and above the normal productivity efforts driven through PPI and PPI Lean projects.

While revenue from LCR locations in 2010 was $500 million, it is expected to cross $600 million in 2011. Besides, facility rationalization not only improves revenue per manufacturing facility (up 32% to $50 million in 2010 from 2006), each consolidation also saves $2–$3 million. These initiatives along with synergies from recent acquisitions are expected to further boost margins ahead.

Similar challenges were witnessed by other companies in the life science tools market. Having witnessed budget constraints in academic and government markets, Life Technologies (LIFE) is working on cost reduction and focusing on R&D initiatives. Illumina (ILMN) also resorted to the restructuring route to navigate through the current headwinds.

Both Thermo Fisher and Life Technologies retain Zacks #3 ranks (Hold) in the short term, in line with Neutral recommendations.

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