We first advocated buying Kendle International (KNDL) back in November, when the shares were trading around $9. After climbing close to $13, Kendle's shares were pounded after a lackluster earnings report and analyst downgrades. Now, the shares are back below $9.
Whenever stocks in our portfolio make precipitous moves, we take the opportunity to re-evaluate our positions. After examining Kendle's Q4 earnings report, we have started to add more KNDL shares to our portfolio. We'd like to update our initial rationale for buying the shares and give a few more reasons why we think the valuation is compelling right now. Here are a few new reasons why we like Kendle:
Honest, Capable Management
We find cheerleading, exuberant management teams to be nauseating, and these sorts of teams all-too-often prove themselves to be dishonest. Kendle's management team tends to faithfully report on the company's performance and to conservatively predict its future. The team seems to be more interested in positioning the company for long-term performance than it is in reporting standout quarterly results. This sort of behavior is both distressingly rare and highly encouraging in today's corporate world.
Recently, KNDL announced some changes in upper management. The company's founding husband-and-wife team is stepping down from its executive roles into what appears to be a semi-retirement (the pair will remain on the BOD). Though senior level management departures are often a cause for concern, we don't find these changes to be alarming. First, it makes perfect sense for a husband and wife to retire simultaneously. Second, Candace Kendle and Christopher Bergen will remain on the company's board, so this doesn't appear to be a situation where former management is fleeing in advance of forthcoming unpleasant news.
Decent Business Outlook
True, KNDL's level of business cancellations were distressingly high in Q4 (and may well remain so in Q1 '11), but gross new bookings were high enough to keep the net book-to-bill ratio above 1. A level greater than 1 means an expanding business. It's important to keep in mind that these figures exhibit great volatility quarter-to-quarter. As such, it's unwise to get too excited or dejected about good or bad quarterly results.
That said, the net book-to-bill has been above 1 for several consecutive quarters, indicating that the business is stabilizing. Also, KNDL's management mentioned several times on its recent conference call that it has seen a dramatic pickup in large RFPs in recent months. While we think it highly unlikely that the CRO business will return to robust growth any time soon, Kendle needs only gradual improvement to leverage its lean cost structure.
Highly Favorable Risk-Reward Profile
We forecast three possible outcomes for Kendle. If the business slows down from its current low level, KNDL shares will, no doubt, decline. However, the company has cut its cost structure, and it has room to continue to do so. Management has neglected to cut more aggressively because it wants to keep personnel in place to take advance of an industry recovery. Since the CRO industry is operating at such a low level, we believe that this scenario is unlikely. However, if it comes to pass, Kendle's operational flexibility means it can weather this storm. In this case, we believe the downside level for the shares is around $7 or $8.
What if KNDL's business continues to gradually improve? In this case, much of the improvement will flow to the bottom line, and the shares should rally modestly. In this case, we think it's reasonable to expect the shares to trade in the $13-15 range.
What if the improvement is more robust? In that case, KNDL would likely trade to $20 and beyond. Though we regard this case as unlikely, it's important to keep in mind this potential upside when assessing the risk-reward profile.
To conclude, we think Kendle's improvement will continue to be gradual. In this scenario, we think the stock could trade up 4-6 points. In the relatively unlikely scenario that the business contracts, we think the downside is 1-2 points. Even before factoring in the likelihood of robust improvement, this is an extremely compelling risk-reward profile. For this reason, we've added more KNDL to our book, and we'll keep our eyes on the shares should market overreactions give us another opportunity to add to the position at even better levels.