- CROs are some of the best opportunities within the healthcare sector.
- Comps valuation indicates Parexel as a clear winner.
- DCF valuation shows the company is fairly valued.
- TA defines $45 as the best entry point.
In my last article, I talked about the 3 major trends expected to affect the near future in the healthcare sector. In this article, I will focus on the second of those trends.
There is, among all the major players in the biopharma industry, the increasing need to react to the ever more present context of the raising healthcare costs. To develop a drug can take 10 to 12 years, and the costs of doing so may end up being in the vicinity of 1 billion dollars (depending of the type of drug and pathology). It's widely known that of all the stages in drug development, the clinical trials stage is the most heavy one in financial terms. Because of that, over the last decade we've been witnessing the emergence of a particular type of institutions that are specialized in certain stages of the drug development process. Among them, a group of companies called Contract Research Organizations (CROs) aim to provide research support to biotech, pharma and medical devices companies, ultimately allowing them to save important financial, human and industrial resources. This group of companies provide such services as preclinical and clinical research, commercialization and even pharmacovigilance surveillance.
A 2013 study reported that the pharmaceutical contract research and manufacturing services (PCRAMS) market is expected to grow above 13% until 2017, which contrasts with the more humble growth rate expected to happen within the global pharmaceutical market. Therefore, it's only normal to look at CROs as some of the big winners of the future biopharma market tendencies. Let's analyze some of them.
- Comparables analysis
There are hundreds of CROs competing for market share, however I've chosen 5 of the most important ones that are traded in the North American stock markets - Charles River Labs (NYSE:CRL), Covance (NYSE:CVD), Parexel (NASDAQ:PRXL), Icon (NASDAQ:ICLR) and Quintiles (NYSE:Q).
At a first glance, all 5 companies trade at a very close multiple, with the exception of Charles River, which seems clearly "cheaper" than the rest. But, as we know, P/E ratios forget to show the impact of important issues like growth and debt, giving us a very narrow view on a company's real value. Let's take a look at growth.
Looking at the last 5 years revenue growth, there is a clear difference between the rates that Icon and Parexel managed to achieve, in contrast with Charles River, that just before looked cheap in the P/E analysis. Seems to be a clear case where a lower P/E is related to diminished expectations surrounding the company's future, and not so much the supposed "cheapness" of it.
Comparing price with growth makes it even more obvious:
One final ratio, which I consider vital as a checkpoint tool in healthcare stock analysis, is the EV/Revenue ratio. This ratio considers the debt values, which can vary considerably between companies, as well as revenue and company size differences. Looking at this ratio one can see that Parexel is trading at lower multiple, of about 1.52X. The average value of the analyzed companies is of ~1.92X.
One final ratio which I consider vital as a checkpoint tool in healthcare stock analysis is the EV/Revenue ratio. This ratio considers the debt values, which can vary considerably between companies, as well as revenue and company size differences. Looking at this ratio one can see that Parexel is trading at lower multiple, of about 1.52X. The average value of the analyzed companies is of ~1.92X.
After all these ratios, a clear winner seems to standout, managing to have above average revenue growth rates and a price level, which even so is not the highest in the industry. However, let's take a look at the real value of Parexel, and see if at the current stock price level, it can be considered a good investment.
- The company
Parexel is amongst the top companies in the industry, with a current market cap of ~3.2B. Its activity revolves around 3 different areas:
- Clinical Research Services, which brings about 75% of all revenue;
- Parexel Consulting, with 11%;
- Parexel Informatics, which provides tech solutions to clinical development, and equates to 14% of current revenue.
One thing that is noticeable is that EPS is growing extremely fast, at rates several times higher than revenues. An analysis of the reason behind this difference seems to point out to improved operational margins, which have risen nearly 50% over the last three years. Even so, it's remarkable that over the last 5 years Parexel managed to improve its revenues at a 14% pace, which is twice the industry standard.
Besides this, Parexel announced last June that it was going to implement a share repurchase program of $150M. Over the last fewer years, total shares outstanding have been diminishing from nearly 60 million to the current level of 56.88M. This has been helping in the higher EPS growth pace.
- DCF analysis
For Parexel's DCF analysis, I considered the following parameters:
Considering a 5-year CAGR rate of 11.41%, we end up with a price per share valuation of $55.2. The company trades currently above $56, which is basically at the model's per share valuation. In this model is also considered a 16% revenue increase due to reimbursements granted.
|Enterprise Value, EV||$3,138.29|
|Value of Equity (VE)||$3,139.67|
|Number of shares||56.88M|
|Price per share||$55.20|
In a recent shareholder presentation Paraxel CFO defined the 10-12% revenue growth range as the company's long-term target. Applying this range to our valuation model gives us a price range between $51.8 and $56.6.
- TA analysis
- Stock more than doubled in the last 2 years.
- The last two big price corrections were of 25.5% on average.
- If a 20% correction happens, Parexel's stock may trade around the $45 barrier.
- Price is near the upper part of the rising wedge and about to enter overbought territory.
- However, any break above the $57/$58 will take the stock to new ground of all time highs.
Parexel has positioned itself as one of the most interesting investment cases in the CRO industry. The company is growing at a faster pace than the industry, as a solid balance sheet and keeps delivering what it has promised.
The main problem seems to be the valuation. The company seems to be fairly priced by the market, trading at the near exact intrinsic value. It's my belief that sooner than later a correction of the overall market is due to happen, and if history is to repeat itself, we may soon see a very interesting entry point. TA shows that a good entering price would be around the $45 value. However, any time a company trades in or near all time highs, it becomes very hard to predict where the next resistance will be. The 20%-25% correction swings seem to predict that the new resistance may be around $70.
Time to be attentive to any breakout, even if I would personally prefer to wait for any correction to enter at a safer price level.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.