IQV - IQVIA Q3: TAS Segment Remains The Problem Child

2023-11-21 12:59:47 ET

Summary

• IQVIA's revenue growth was below estimates, but adjusted EBITDA and EPS beat expectations.
• RDS segment showed strong demand and growth, with a stable backlog and positive indicators for FY24.
• TAS segment continues to face challenges, with weak quarterly growth and concerns about client negotiations and demand conditions.

Summary

Readers may find my previo us coverage from September via this link . My previous rating was a hold, as I believed IQVIA ( IQV ) stock would remain rangebound in the near term as the outlook was weak. The weakness stemmed from IQV technology and analytics solutions [TAS] and contract and medical solutions [CMS] segments facing delays from customer spending and that research and development solutions [RDS] were undergoing normalization in bookings. I am reiterating my hold rating despite demand remaining strong in the RDS segment. TAS is still a large part of the business, representing ~44% of gross profit, and it is going through a rough patch with the FY24 outlook being very uncertain. My recommendation to hold is likely to persist until I see a clear path to recovery in the TAS segment.

Comments

IQV 3Q23 's results were announced on November 1st. Reven ue was $3.736 billion, representing growth of 4.9% on a reported basis and 4.1% in constant currency. Though positive, the results were below consensus estimates and management’s guided range of $3.76 to $3.81 billion. However, adjusted EBITDA of $888 million grew higher than expected, surpassing consensus estimates of $881 million and being within the guided range of $880 million to $895 million. Along with the adj. EBTIDA beat, IQV also beat on EPS with $2.49 vs consensus estimate of $2.43. Looking ahead, management reduced their revenue forecast for 2023 from $15.05 billion to $15.175 billion to $14.885 billion to $14.92 billion. EBITDA was also guided down to $3.56 to 3.57 billion vs the previous range of $3.6 billion to 3.635 billion. Lastly, EPS was also guided down to $10.16 to 10.23, vs. previous range of $10.20 to $10.45.

This post will focus on the RDS and TAS segment as they are much larger than CMS.

First, it was encouraging to learn that the RDS segment demand remains robust and that management anticipates growth above market levels. In the quarter, R&DS revenue grew 7.2% on a reported basis and 6.4% on a constant currency basis to $2.122 billion. The results of the third quarter eased my concerns that the normalization of bookings would have a negative effect on growth. In the quarter, RDS backlog increased by 10.5% (constant currency basis) to $28.8 billion, which is relatively stable compared to the 11% growth seen in 2Q23. Of the total backlog, $7.4 billion worth of backlog is expected to be converted into revenues within the next 12 months. This represents roughly 90% of the revenue generated over the past 12 months, providing strong visibility into the growth outlook for FY24. There are also several other positive signs that point to RDS seeing a strong FY24. First, in 3Q23, management observed growth in all customer segments and a 10% increase in the flow of RFPs [requests for proposals]. The latter is a very positive signal, as it indicates the potential demand that has not been booked into the pipeline yet. Second, management saw the highest EBP funding of the year at $18.7 billion. Third, the increase in R&D spending by large pharma companies, which is now over 20% of net revenues, is perhaps the most encouraging forward-looking indicator.

"Year-to-date, EBP funding through Q3 was up 8% versus prior year. If you look at the first half large pharma R&D spend, it was above 20% of net revenues, highlighting continued strong R&D activity within large pharma as well." Source: 3Q23 earnings

Unfortunately, TAS faces ongoing headwinds, as quarterly growth is weak due to persistent demand weakness. While RDS continues to perform well, I think the market is unlikely to give credit given the negative sentiment around TAS. TAS customers are delaying making decisions and enacting cost-cutting measures, in contrast to those of RDS customers. The impact was quite evident, as IQV failed to see the improvement that should have materialized if normal seasonality stayed put, signaling that underlying demand conditions are really bad. The outlook isn’t pretty either. In the call, management mentioned that the analytics and consulting segment continues to see further declines, and they expressed concern that their large pharma clients are becoming more aggressive in their negotiations of terms and pricing. All of these, in addition to the 3Q performance, have really muddied the FY24 outlook. While management is expecting a rebound in demand in 2024, that guide is based on what they are seeing in their pipeline today. I will not be putting a lot of faith in this guide as some projects are already falling off the pipeline, which means the backlog is not a really good indicator of FY24 growth. Given the state of things, I am refraining from making any assumptions on how TAS might play out in FY24. Instead, I would just stay on the sidelines and monitor the situation.

"I'm sure you also saw that several large pharma have announced significant cost reduction programs and, obviously, we are a significant vendor to large pharma.

And so, the consulting and analytics part of our business, which, as you know, is about a quarter of our revenues, is showing sharp declines, sharper than we would have expected. Some of the projects have simply fallen off. But the pipelines are still there." Source: 3Q23 earnings

Valuation

In my model, I hold a very conservative view given the weakness seen in TAS business (delay in pipeline on more discretionary projects as pharma continues to look to manage expenses).

Specifically, I modelled:

1. FY23 revenue to be annualized from the 9M23 performance
2. 10% growth in the R&DS business in FY24 (similar to the 3Q23 performance on a constant currency basis), which is supported by the backlog visibility (90% of next 12 months revenue are booked)
3. Flat growth in TAS in FY24 given the continuous headwind
4. Flat growth in the CS&MS business (I am less focused on this segment, hence, I just assume flat)

Altogether, I expect 2.9% growth in FY23 and 7.2% growth in FY24. As for profitability, I am using management adj EPS guidance to back into an implied FY23 adj net income guidance. I am keeping this margin expectation flat for FY24. In FY24, I expect IQV to generate ~$2 billion in net income. With the headwinds faced in TAS, I would not expect valuation to see any positive momentum, hence, I expect valuation to stay at the current levels (19x forward earnings). With these assumptions, I have a price target of $205, close to the price that IQV is trading at today.

Conclusion

My hold rating remains for IQV due to ongoing challenges within the TAS segment, which is a substantial portion of gross profit. Despite robust demand in the RDS segment, TAS faces persistent weakened demand. In particular, the uncertainties surrounding TAS's recovery and management's cautionary remarks about large pharma clients negotiating aggressively lead me to maintain a watchful stance, refraining from making assumptions about TAS's FY24 prospects until clearer signs of improvement emerge. Management's lowered revenue forecast for 2023 and reduced EBITDA and EPS guidance further underscore TAS's struggles.

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