Q&A – Q4 Earnings Recap
A couple weeks ago I posted my quarterly recap of key takeaways from the earnings reports and conference calls of certain companies I follow. This week’s newsletter will address several questions I received regarding the recap.
How exposed are Chinese CROs to the US clinical trials market?
The figures below reflect these companies’ total revenue exposure to US customers, not necessarily restricted to clinical trials.
The exposure is significant, and while US legislative focus is targeted towards Wuxi, it’s reasonable to expect a chilling effect across all Chinese CROs seeking to do business with US biopharmas.
Did Fortrea’s legal issue affect its decision to sell its Enabling Services business?
No. Not only did Fortrea never refer to this issue in relation to selling the Enabling Services business, in a separate filing Fortrea said the key component of that business (Endpoint Clinical) was not involved in the programming / sequence error the legal issue was related to. The error related to a third party vendor, whose identity has not been disclosed due to contractual reasons.
Why are some CROs like ICON trading at all-time highs, while others like IQVIA are not?
In the recap, I mentioned Medpace, Fortrea, and ICON are at / near all-time highs, while IQVIA is ~10% off and Thermo Fisher ~12 % their all time highs. Fortrea only went public last summer, so its stock continues to be highly volatile while institutional investors do their due diligence to determine what kind of position to put on it. Medpace is a perennial high performing company with industry leading growth rate and margins, and a pristine debt-free balance sheet.
ICON and IQVIA are interesting cases. I’m speculating but have assumed ICON did not reach the types of valuations seen by IQVIA during the 2021 COVID stock bubble because it was digesting the PRA acquisition, while IQVIA rode the wave while benefiting massively from an influx of fast burning COVID backlog. All in all, my take is that IQVIA simply has a higher hill to climb to get back to its all-time highs. IQVIA is certainly not underperforming ICON, either competitively or financially.
Thermo Fisher only has a small portion of its revenue tied to CRO services, so its valuation drivers are related to its other core businesses.
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Why would a CRO like Medpace go debt-free, while others continue to hold large debt burdens?
For companies like IQVIA and ICON, debt levels reflect decisions around debt leverage ratios, interest rate exposure, and flexibility to do M&A. They have the balance sheet and cash flow to rapidly pay down debt if they wanted to- instead, they have been looking to refinance variable debt to fixed interest rates to bring down their interest rate expense. Both companies do quite a bit of M&A and want the firepower on hand to take advantage of opportunities as they arise.
Medpace does zero M&A, focusing its capital allocation instead on debt reduction (which is now complete), returning capital to shareholders through stock buybacks, and organically expanding its service offerings and geographic presence. I could see them adding a dividend at some point, though they’ve stated there are no current plans to do so.
Fortrea doesn’t have a choice. LabCorp loaded them up with debt as part of the spinoff, so they will be using a sizeable portion of free cash flow and the proceeds of selling a large business unit to pay down and restructure debt over time.
Why do you think employee turnover is decreasing so rapidly across these companies?
Employee turnover appears to be largely returning to pre-COVID norms. These companies suggested turnover is declining even further below pre-COVID levels, but I’d be surprised to see that sustained unless there is an economic downturn.
COVID, and government responses to it, drove major disruptions and shortages to the labor market, as I’m sure we all remember. These forces have dissipated, yet live long in the memories of CROs and service providers across many other industries. You are seeing intense efforts to tightly manage headcount growth against revenue growth, and technologies are gradually coming on board to help facilitate this. Biotech funding has recovered but, from what I’m seeing, hiring is still very restrictive. A combination of tightly managed CRO and biopharma hiring appears to be keeping currently employees at their current companies for longer.
Any insights into Certara?
I track Certara but have not written about them to this point. Most of my readers are familiar with Pinnacle21 software, which Certara owns, but Certara offers a number of other products and services around biosimulation for drug development.
They are struggling to maintain consistent growth despite numerous acquisitions in recent years . Their share price has consistently lagged the market to a significant degree. Interestingly, they’re about the only company I follow who attribute a significant part of last year’s weakness to Inflation Reduction Act related “reprioritization” of customer spending. They’ve been a hard read for me, but I’ll look to include something on them next quarter.
That wraps up this Q&A for the Q4 earnings recap. Thanks as always for reading.
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