Charles River Labs Has A Great, Long-Term Story To Tell

Summary

• Charles River reported Q4 2018 results that beat the top- and bottom-line estimates.
• This small-cap drug discovery and early-stage development company has a great long-term story to tell. Additionally, I believe that the company's investment thesis keeps getting stronger.
• I am long Charles River, and I am looking to add to my position in 2019.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Start your free trial today »

Charles River Laboratories (NYSE:CRL) has been one of the best-performing stocks in the R.I.P. portfolio. CRL's shares are up 24% on a YTD basis, and the stock is outperforming the S&P 500 (SPY) by almost 25 percentage points over the last 12 months.

Data by YCharts

Investors may be asking themselves if they missed the boat, but I would contend that the story is just getting started. As such, I believe that Charles River is a great, long-term buy at today's price, because, as I recently described, this drug discovery and early-stage development company is well-positioned for the future. And the company's most recent results prove it.

The Latest, Encouraging Numbers From Top To Bottom

On February 13, 2019, Charles River reported Q4 2018 results that beat the top- and bottom-line estimates. The company reported adjusted Q4 2018 EPS of $1.49 (beat by $0.09) on revenue of $601.5M (beat by $11.0M), which also compares favorably to the year-ago quarter.

Source: Q4 and Full-year 2018 Earnings Presentation

The highlights:

• Quarterly revenues were $601.5M, an increase of 25.7% YoY (with organic growth coming in at 11.4%).
• Cash flow from operations increased by 38% YoY (to $441M).
• Adjusted net income was $73.2M (YoY increase of 7.3%), and non-GAAP operating margin was 20.3% (60 bps improvement from the prior period).

Charles River finished fiscal 2018 with a bang. The company reported broad-based growth to end the year, but, in my opinion, the real standout for the quarter was its discovery and safety assessment ("DSA") operating segment.

Source: Q4 and Full-Year 2018 Earnings Presentation

As shown, revenue increased by over 40% for the quarter and by over 30% for the fiscal year. DSA has been an area of focus over the last two years, as shown by the quarterly/annual contribution from acquisitions, and it is encouraging that these newly acquired investments are already paying huge dividends. The earnings numbers are nothing to brag about, but let's remember that the management is heavily investing in this business, and these expenses are being made with the future in mind. As such, the earnings pressure should be viewed as a short-term headwind that will eventually turn into a long-term tailwind.

Moreover, as described by management during the conference call, DSA should be viewed as the company's main growth driver for the quarters ahead. This operating unit alone is enough of a reason to hold onto your CRL shares, but it's important to also note that management has Charles River's entire business firing on all cylinders.

For example, the company's full-year 2018 results were just as impressive.

Source: Q4 and Full-Year 2018 Earnings Presentation

2018 was Charles River's highest annual organic revenue growth since 2007 and, looking ahead, management anticipates for the strong results to continue in 2019.

Source: Q4 and Full-Year 2018 Earnings Presentation

During the conference call, management talked about the fact that the industry has strong fundamentals and that it has taken the necessary steps to properly position Charles River for the future. So far, so good. Moreover, in my opinion, there are no signs of this company slowing down anytime soon.

Simply put, Charles River has a great, long-term story to tell (and it may actually be getting stronger).

The Long-Term Story Remains Intact

Charles River's scientists worked on 80% of all drugs approved by the FDA in 2017, and more importantly, the company partnered with each of the 100 largest biopharmaceutical companies in the world. This Contract Research Organization ("CRO") is viewed as a critical partner to its customers, and Charles River's portfolio of businesses allows the company to be a real value-add to its clients' research, discovery, and safety assessment processes.

Source: Company Presentation, November 2018

Acquisitions have been (and will likely continue to be) a significant part of the long-term story for this company. MPI Research (acquired in August 2018) and KWS BioTest (acquired in January 2018) are already major contributors to the company's operating results. So, in my opinion, investors should expect more of the same with the recently announced deal for Citoxlab.

Citoxlab is CRO company that specializes in safety assessment and discovery services and, as management described, the proposed acquisition would further strength Charles River's position in the early-stage CRO space, specifically within the outsourced safety assessment market. Similar to MIP and KWS, investors should expect for these assets to provide benefits to Charles River's business almost immediately, if the deal goes through.

Charles River's story is straightforward: this company is a vital part of its customers' business processes. The company provides value-added products and services that are fully integrated into most of the drug discovery and development processes around the globe. Furthermore, management continues to tuck in valuable assets, which allows it to provide additional value to its customer base. Charles River is viewed as critical business partner, and rightfully so, for most of the major players in its industry.

Valuation

Based on historic metrics, CRL's shares are trading at a reasonable valuation at today's price.

Source: Seeking Alpha

Additionally, shares are trading slightly above 21x 2019E earnings (per Yahoo! Finance). While this valuation is not cheap, I believe that Charles River's story gets even more impressive the further that you are able to look out. Therefore, this small-cap company has the potential to more than grow into its current valuation in 2019/2020.

Risk

Investing in small-cap companies comes with many risks, but the major risk for Charles River is related to the company's reliance on pharmaceutical and biotechnology companies. If these companies cut back their operations and/or outsourcing needs, Charles River's business would be negatively impacted.

Additionally, as mentioned above, the company's growing debt balance should be closely monitored in 2019. Please also refer to Charles River's 2018 10-K for additional risk factors that should be considered before investing in the company.

Bottom Line

At the end of the day, Charles River's 2018 results and management's forward guidance support the thought that this company is well-positioned for 2019 and beyond. The acquisitions have not only been a significant part of the long-term growth strategy, but they have also already been major contributions to the company's recent operating results. Expect more of this to happen in 2019, especially if the Citoxlab deal goes through. Therefore, investors with a time horizon longer than three to five years should consider adding CRL shares on pullbacks.

Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.

Disclosure: I am/we are long CRL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.