Medpace: Underestimated Profiter Of The Biopharma Trend

Summary

• Medpace supports the biopharmaceutical industry with state of the art research methods to accelerate the approval of drugs.
• The CRO market is highly competitive, but the CEO specializes in a niche that allows almost predictable sales for the upcoming years.
• The company is profitable with EBIT margins around 18% and continues to post strong organic growth rates over 20%.
• Valuation remains reasonable despite recent capital gains due to growth perspectives and profitability.

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Investment Thesis

An investment in a biopharmaceutical company can be promising because of high growth rates, outstanding profitability and great returns in case of success. On the other hand, there are also significant risks. Many small companies in this industry will not generate a cent of revenue in their entire life cycle, high dependence on one product, patents expire, or growth rates of products do not meet expectations. To get around this, I invest almost exclusively in profitable companies, have established multiple compounds and have a strong pipeline, such as Bristol-Myers Squibb (BMY) or Vertex Pharmaceuticals (VRTX). But there is an essential risk that I cannot eliminate.

The failure of critical active ingredients in one of the clinical phases is the worst case in the late phase, where the company has already invested much money. Such events can have a substantial impact on the share price and the company's future and can turn an investment into a flop, regardless of general growth in the industry. Therefore, the question arises of how an investor can benefit from the opportunities of the biopharma market without having to bear these significant risks. Well, he could buy an ETF on the Nasdaq Biotechnology (IBB) or similar indices. However, if he wants to participate in operational performance directly, Medpace (NASDAQ:MEDP) could be an exciting company.

Medpace is a big profiter of the biopharma trend while having a significantly lower risk profile than a typical biopharma investment. Yet Medpace delivers very respectable growth rates, operates highly profitably, and specializes in one area of the CRO market. This makes Medpace an exciting investment for me and especially for investors who usually avoid the biopharma sector but still want to profit from the promising development of this sector more conservatively. In the following paragraphs, I clarify my bullish perspective on this underestimated profiter.

Company Overview

Medpace supports the biopharmaceutical industry with state-of-the-art research methods to accelerate the approval of drugs. Active medical ingredients require an intensive research process before their market approval. The healthcare industry must be able to find new active ingredients while guaranteeing safety. The health authorities such as the Food and Drug Administration (FDA) of the USA or European Medicines Agency (EMA) of the EU have strict requirements. Elaborate studies must be conducted that take an average of 10 to 15 years. Only when an active ingredient passes phase 1 to phase 4 is it approved for the market.

For smaller biotech companies, in particular, these stringent requirements can prove to be significant hurdles, as they are generally not specialized in dealing with the authorities. This often results in additional costs or unnecessary delays due to errors in the conduct of studies or the submission of applications. Since most companies in this industry are unprofitable or do not even generate revenues, they have limited budgets that should not be wasted on such formal carelessness.

Medpace offers these companies to outsource the studies and related tasks to an experienced and experienced team. This ensures optimal study execution with high-cost efficiency and best time management. The demand for these services is high, and many of these studies are nowadays run through so-called CROs. The market is growing at about 9% per year, and Medpace is constantly gaining new market share, making the company appear attractive. However, with a market capitalization of $7.48 billion and annual sales of $925 million, Medpace is still a fairly small player in this sector.

Financial Performance

It has been a strong year for Medpace so far. The stock price has climbed by more than 50% YTD, impressively outperforming the S&500, which is "just" up 24%.

Source: seekingalpha

This increase was partly due to q3 solid results, which enabled the share to gain more than 20% within four days. Recently, the stock came back somewhat, which I consider an exciting entry opportunity. But first, let's take a closer look at the Q3 figures. The company posted revenues of $295.5 million, up 28% Y/Y on net income of $48.5 million, or $1.29 per share, a Y/Y growth of 17%. The company posted revenues of $295.5 million, up 28% Y/Y on net income of $48.5 million, or $1.29 per share, a Y/Y growth of 17%.

Revenue was slightly ahead of Wall Street expectations. An impressive 20% beat earnings per share estimate led to an upgrade of the FY guidance from $4.31-4.50 to $4.66-4.77. The revenue forecast was unchanged between 1,135 and 1,145 billion, with a 23% Y/Y growth prospect. Overall, I see it as very positive that Medpace can already show constant EBIT margins at 18% despite the strong sales growth, which is a quality characteristic of a growth company. A gross margin of 62% also indicates that there is still plenty of room for an improvement in the operating margin.

The company's balance sheet also looks excellent with no debt and a steadily increasing cash position of currently $400 million.

Further growth ahead

There is intense competition in the CRO sector, and Medpace is a relatively small player with few opportunities to expand, one could assume. However, they have a decisive difference from their competitors in their service. Competitors often take over isolated studies from the small pharmaceutical companies, for example, only conducting a phase 2 study. Medpace, on the other hand, always takes over the complete process of an active ingredient from phase 1 to market launch. Medpace does not manage individual studies. The advantage of this is that studies are conducted at maximum efficiency without mixing different concepts. This results in cost savings and faster study execution.

This commitment to a holistic solution naturally reduces the addressable market, differentiating Medpace from its competitors and serving its niche. In addition, the fact that the entire drug approval process often extends for more than ten years through the three phases means that revenues in the coming years are becoming increasingly predictable. This fact makes the core business significantly less cyclical, making it less susceptible to economic downturns.

It is additional security that not many companies can offer, and for me, it was also a decisive reason to buy the share. Medpace is expected to grow significantly faster than the CRO market, which is currently estimated to grow at 8,5% annually due to this prime positioning. Also, as the active ingredients of study procedures become more complex due to technological advances, the demand for Medpace's holistic solutions is expected to increase significantly more than individual studies.

CEO August Troendle is also a visionary who is keenly aware of regulatory hurdles and issues, working for the FDA himself. He has created solid organic growth without major acquisitions of smaller competitors, as is common in the industry. The CEO also remains confident in the direction of his company, as 18.5% of the shares are owned by him. The bullish view is also supported by the analysts' revisions, who, after the earnings call, adjusted their estimates sharply upwards not only for this year but also for the next few years. Wall Street gradually recognizes the potential, but I am convinced that expectations are still too conservative.

Source: Seekingalpha Premium

Valuation

Medpace is currently valued at a price/sales of 6.5 based on 2021 revenue of 1.140 billion. Based on the earnings estimate of $5.05 per share, the P/E is 41. Both values look pretty expensive at first glance and are above the historical average. A comparison of the metrics with the peer group (IQCIA (IQV), PPD, Inc. (PPD) and ICON Public Limited (ICLR)) shows that Medpace is not the cheapest company, but it is the most profitable. The high profitability explains why investors are willing to pay a premium.

Source: Author's calculations, seekingalpha

Fair Value

To calculate the fair value of Medpace, I have to make some assumptions:

• Sales are growing with 20% CAGR 2022-2026 and with 14 CAGR 2027-2031
• EBIT-Margin slightly increases to 25% in 2031
• WACC of 9%, Tax-rate 21.5%
• Terminal growth rate 2,5%

The easiest method would be to assume that investors will pay at least an EV/EBIT of 20 in 2031 for the company, which would be well below the sector average. Multiplied with the forecasted FY 2031 revenue, this would mean a potential market capitalization of $28 billion in 2031. Compared to current levels, it indicates a 14% annual rate of return. Assuming at fair EV/Sales of 5 in 2031 would implicate a similar rate of return.

Finally, I run a discounted cash flow analysis, but I prefer taking net income for this instead of free cash flow for the sake of simplicity. Free cash flow is usually higher, so my analysis is a bit more conservative. With the assumptions taken above, I become a fair value target at $301, and the price target is around 46% higher than the current price. Given these price targets, Medpace remains very attractive despite above-average metrics, and the growth perspectives are good enough to justify the current premium.

Risks to consider

As I have already mentioned, the risks with Medpace are minimal. Nevertheless, they should not be left unmentioned, of course, but one must also critically scrutinize one's investment. Even the probabilities of occurrence for the risks are very low. The most significant risk for Medpace would probably be that demand for Medpace services declines due to shorter studies or more straightforward approval procedures. This would result in substantial revenue losses. This thought could arise at least given the rapid vaccine approval of BioNTech (BNTX), Moderna (MRNA) or Johnson & Johnson (JNJ).

However, this was an exceptional situation due to urgency. Overall, it remains doubtful that the health authorities will simplify the hurdles for an active ingredient to reach market maturity. After all, these authorities must be able to guarantee the health and safety of patients. Safety requirements are more critical than ever, especially with the increasing complexity of individual active ingredients based on novel technology. Therefore, the trend is toward more lengthy procedures rather than shorter ones.

Another risk would be an unexpected flattening of growth rates. The industry is very competitive, and other companies can stop Medpace's ongoing expansion by lowering their prices, for example. In this case, Medpace would probably lose its premium in valuation over its competitors, and its prospects would be diminished. Realistically, such an aggressive pricing policy could cause Medpace to miss out on some orders.

However, despite their size, they have the highest margins in the industry, which on the one hand, shows that they are one of the most efficient companies in the CRO market and that they are most likely quality leaders in their niche. Their quality leadership means that customers are currently already willing to pay a higher price for Medpace services. Accordingly, lower prices from competitors are unlikely to burden the company, and it is more likely that a major competitor will acquire Medpace outright rather than engage in a competition. This scenario, in turn, would only have advantages for shareholders.

Conclusion

Medpace is one of the best opportunities to participate in a strong-growing biopharma market without the crucial capital losses made by essential study flops. While investing in an ordinary biopharma company, there will always be the threat of massive disappointment when a primary blockbuster drug does not successfully go through all phases, which cause the sales of these companies to remain uncertain.

In contrast, Medpace is not dependent on the success of medical studies. Instead, by exclusively offering holistic care through all phases, revenues become almost predictable while the risks are relatively low. After all, such processes take many years. This unique selling proposition makes Medpace my favourite in the CRO industry and makes me very confident for the years to come. The recent setback represents a buying opportunity for me, as the valuation and the prospects still allow for significantly higher prices.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of MEDP, BMY, VRTX either through stock ownership, options, or other derivatives. 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.