Waters Earnings: Margin Expansion Help Profits Withstand China and Currency Headwinds

Wide-moat Waters WAT reported weak China demand in the third quarter that was more than offset by margin expansion on the bottom line. However, continued China and currency challenges caused management to push down its 2023 sales and adjusted EPS guidance a bit. At first glance, this reduction in 2023 expectations does not materially affect our $323 fair value estimate, though, and shares look moderately undervalued.

In the quarter, Waters reported a constant-currency revenue decline of 4%, which was on the low end of expectations and included weak demand in China while other geographies grew in the low single digits. Easily delayed instrument sales remained the culprit for the quarter’s weakness, declining 13% year over year, while recurring revenue grew 4% in constant currency. Instrument sales could eventually rebound as sentiment improves in key end markets, especially given Waters strong new product portfolio that is supporting higher prices. With significant gross margin expansion and other cost controls causing operating margins to rise 380 basis points in the quarter, adjusted EPS grew 8% year over year to $2.84 in the third quarter, or well above management’s previous expectation for $2.50-$2.60.

Near-term uncertainty in China and currency headwinds caused management to reduce its 2023 expectations, though. Specifically, Waters now expects a constant currency sales decline of 1% to 2%, down from 0.5%-1.5% growth previously, and adjusted EPS of $11.65 to $11.75, down from $12.20-$12.30 previously. This lower 2023 earnings guidance includes a larger China headwind than expected—a potential sales decline around 25% in 2023 versus a low-double-digit decline expected previously—and 250 basis points of additional currency headwinds on earnings than anticipated previously. While we have tinkered with our near-term expectations, our long-term views for Waters and the life science industry remain intact, and shares appear attractively valued to us.