Given the highly uncertain outlook for earnings and cash flow this year as a result of COVID-19, we wanted to assess each company’s comfort level vs. financial covenants where applicable and benchmark liquidity vs. recent cash flows. In short, liquidity is 2-3x annual cash flow and the CROs average a ~45% EBITDA buffer vs. covenants.
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Yesterday a trial date was set for the opioid multidistrict litigation (MDL) Track 2 bellwether case in West Virginia following a status conference. Recall that the Track 2 bellwether case consists of Huntington, WV and Cabell County’s cases against ABC, CAH, and MCK. The trial is scheduled to begin on 8/31. Both the plaintiffs and defendants will have 6 weeks to present their cases, and inclusive of breaks in the schedule the case would run through the week of 12/14. Plaintiffs wanted the trial to start almost immediately, the and defendants had argued that a trial before the summer of 2021 “would be rushed”.
CROs have underperformed both the S&P 500 and XLV this week as fears of a coronavirus contagion have grown. We are quite obviously not epidemiologists and are making no predictions about when the coronavirus outbreak will be contained and impacted companies and industries can resume normal operations. Instead what we thought what would be helpful is to consolidate everything the CROs said on coronavirus during Q4 earnings calls and to summarize / compare guidance assumptions across the companies. We also note the time elapsed since these comments were made, with all but MEDP coming before the escalation of concern over the weekend.
We are upgrading CRL to Outperform from Peer Perform and increasing our year-end 2020 target price to $203, 15% upside. Last week CRL reported strong Q4 results and issued guidance that to us appears to be extremely conservative regarding margin assumptions, which we see as likely to produce material EPS revisions through the year. Further, our analysis suggests CRL could potentially reach its 20% operating margin target as soon as this year. While CRL has outperformed the S&P 500 and XLV by ~11% since it reported, we see a path to further upside from here – with potential #s upside and a significantly lower degree of difficulty on the margin improvement story justifying a higher multiple in our view.
This morning (2/11/20) CRL reported 4Q19 adjusted EPS of $2.01 vs. Wolfe/Consensus EPS of $1.80/$1.84 and implied guidance midpoint of $1.83. Both revenue and margins were better than expected in Q4, with DSA driving upside on both fronts. CRL introduced 2020 EPS guidance of $7.45-$7.60 vs. Wolfe/Consensus of $7.28/$7.43, with organic revenue growth expected to be 7.75-8.75% vs. 2019 organic revenue growth of 8.5%. The quarter and guidance should both be well received.
We are updating our year-end 2020 target prices to reflect the current S&P 500 multiple, which has increased over the past couple of months. Our target prices for all companies remain based on relative valuation. While we are not changing any relative target multiples with today’s note, we are using this opportunity to increase the size of the headline opioid litigation exposure imbedded in our distributor target price framework from $20B to $25B. Net, our CRO and Lab targets increase and our Distributor targets decrease slightly. See inside the note for our methodology.
In December CRL announced a definitive agreement to acquire HemaCare for approximately $380 million in cash, and the deal closed last week – consistent with previous guidance for an early 1Q20 close. While the deal is certainly expensive w/ limited NT accretion (see Page 2), we expect it will improve organic growth in the RMS segment meaningfully if growth meets CRL’s expectations (more below). We are updating our estimates to include the deal and also updating our CRL target price, which increases primarily due to a higher S&P 500 multiple. We maintain our Peer Perform rating as we see higher estimate achievability and potential for further multiple expansion elsewhere within our coverage.
Today (12/16/19) CRL announced a definitive agreement to acquire HemaCare for approximately $380 million in cash. HemaCare produces human-derived cellular products for the cell therapy market and supplies biomaterials and cell processing services to support the discovery, development, and manufacture of cell therapies. It serves biotechnology and pharmaceutical companies, academic institutions, and other research organizations. The acquisition is described as complementing CRL’s early stage portfolio by forming a unique solution for cell therapy developers and manufacturers. Cell-therapy solutions currently represent $100M of CRL’s revenue. The company sees the addressable market for HemaCare’s products expanding from $200M today (implies ~20% share) to $2B over the next 10 years. The deal is expected to close early in 1Q20.
On 11/6 CRL reported 3Q19 results that were slightly below expectations on revenue and above on EBIT and EPS, generally in line with the preannouncement on 10/21. CRL lowered revenue guide by ~1% on FX and lower organic growth and raised EPS slightly on tax rate. The stock underperformed the XLV by 5.1% from preannouncement to the full earnings report, and has outperformed by 1.8% since.
On Wednesday 11/6 the Wolfe Healthcare team hosted our first annual conference in NYC. The conference included fireside chats with covered companies across the healthcare spectrum as well as panel discussions with DC experts, not-for-profit insurers and PBM leaders.
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