CTLT - Catalent: Debt Remains An Overhang

2023-12-13 11:14:23 ET

Summary

• Today, we revisit drug manufacturer Catalent, Inc., which has expanded its board membership at the behest of activist investor Elliott Management.
• Analysts remain skeptical about Catalent's turnaround story, but the company has made progress and has brought in new directors and executives.
• An updated analysis of Catalent, Inc. follows in the paragraphs below.

An emotional debt is hard to square ."? Iceberg Slim.

Today, we are circling back on Catalent, Inc. ( CTLT ) . When we last looked at this drug manufacturer in July, we noted the company has several things to " fix" about its business. The firm had also drawn the attention of activist investor Elliott Management. Catalent has expanded its board membership and also posted quarterly results in November. The shares are also down some 25% since we passed on any investment recommendation on the stock.

Is Catalent in the " buy zone" yet? An updated analysis follows below.

Company Overview:

This New Jersey based drug manufacturer operates via two business segments: Pharma and Consumer Health. Catalent is focused on developing and manufacturing solutions for drugs, protein-based biologics, cell and gene therapies, and consumer health products. The stock has fallen to just over $37.00 a share since we last looked at it and sports an approximate market capitalization of just north of $6.8 billion. The company's fiscal year ends on June 30th.

Like so many in the biopharma and diagnostic space, the company is dealing with the " COVID Cliff" as sales related to the coronavirus have fallen dramatically since the disease became endemic. Since we last visited Catalent, the company entered into a cooperation agreement in August with Elliott Management that added four new directors, expanding its board to 16 members. Catalent also agreed to do a " business review" of its operations. Two weeks prior to this announcement, a shareholder lawsuit was filed against the company alleging the company " misrepresented its revenues and exaggerated demand for products during a period from 2021-2022 ."

First Quarter Results:

Catalent posted its Q1 2024 numbers on November 15th. The company delivered a non-GAAP profit of 34 cents a share, when the Street was expecting a 13 cent a share loss. Revenues fall nearly four percent to $982 million, which beat the consensus estimate by just over $40 million. Equating for COVID sales, organic revenue rose five percent on a year-over-year basis. COVID-related sales dropped to $100 million during the quarter from $185 million 1Q2023.

On a GAAP basis, the company had a net loss of $715 million, which is almost entirely due to a non-cash goodwill impairment charge of $700 million.

While sales declined sharply in its Biologic segment, they would have been up 11% outside of Covid and a non-recurring licensing deal in Q1 2023. The company is estimating less than $100 million GLP-1 revenues in FY2024, but as new programs come online and demand for these drugs continue to increase, leadership believes this is at least a $500 million opportunity for Catalent, as it expects the company to be the leading CDMO in this fast-growing space.

Sales also rose five percent to $535 million in Catalent's Pharma division. Management expects Consumer Health sales to decline in the first half of fiscal '24 and return to year-on-year growth in the second half of the year thanks to a recent contract. Management reaffirmed overall FY2024 guidance, with the notable revision that it now sees overall COVID revenue of $180 million in FY2024, a $50 million boost from previous guidance.

Analyst Commentary & Balance Sheet:

The analyst community remains skeptical on Catalent's turnaround story at the moment. Since fiscal first quarter results were posted, five analyst firms including Wells Fargo and JPMorgan have reissued Hold/Sell ratings on the stock. Price targets proffered range from $40 to $48 a share. However, Robert W. Baird upgrades the shares to a Buy with a $53 price target (up from $45 previously), while RBC Capital ($55 price target, down from $58 previously) maintained its Buy rating on Catalent.

Just under six percent of the outstanding float in these shares is currently held short. Elliott Management added 4 million shares to its stake in CTLT in the third quarter. Two company directors also added $1.1 million in shares collectively within a month of the board expansion announcement.

The company ended the most recent quarter with just over $200 million worth cash and marketable securities on its balance sheet against $4.95 billion in long-term debt. Catalent's net leverage ratio end the quarter at 7.4x, compared to 6.4x at the close of the previous quarter and 3.2x in the same period a year ago. The company is well under its covenants as far as key leverage rations on its senior secured credit agreement it should be noted. Its first debt maturity is also not until 2027. Management has guided to at least $100 million worth of free cash flow in this fiscal year. This is up from previous guidance of breakeven cash flow for FY2024.

Verdict:

Catalent booked $1.00 a share in profits in FY2023 on $4.28 billion of revenues. The current analyst firm consensus sees earnings falling to 80 cents a share in FY2024 on sales of $4.38 billion. They project profits rebounding to $1.62 a share in FY2025 as revenues rise seven percent.

The company has made some progress since we last looked at it, as Catalent has brought in new directors and a new President of its Biologics division in late September. The company named a new CFO in July of this year as well. Conclusion of Catalent's "business review" is likely to result in further changes around operations, strategies and capital allocation priorities.

That said, even with the recent drop in the share price, the stock is hardly compelling on a valuation basis at over 45 times forward earnings. Catalent's debt levels remain concerning even as the company projects it will generate positive cash flow in FY2024 and its weighted interest rate on its debt is currently 4.7%. The company's recent FY2023 10-K also reads like novel as far as potential risks to the business.

Elliott Management seems to be dedicated to help turn around Catalent's fortunes. However, until further progress is made on the business side and also paring down debt levels, I remain on the sideline in regard to Catalent, Inc. stock.

No credit--no debt. Credit leads a man into temptation. Cash down is the only thing that will deliver him from evil ."? Solomon Northrup.

For further details see: