2023-04-20 14:20:09 ET
Summary
- Catalent is a contract manufacturer catering to the pharmaceutical industry.
- The company's share price rose >$120 during the pandemic owing to the additional revenues the company earned helping manufacture COVID vaccines.
- The company's share price has nose dived, however, owing to issues at three of its plants. That means FY23 guidance will almost certainly be missed.
- The current low valuation may be overblown, however - Catalent has historically grown revenues in almost every year and been profitable - one bad year can be forgiven.
- Post-pandemic, the company can thrive again in a BAU environment - and M&A rumors may surface again soon if the valuation remains low.
Investment Overview
Bear run on Catalent stock changes business from substantially overvalued to significantly undervalued
Over the past five years the share price of Catalent (CTLT) - a company focused on the provision of "differentiated development and manufacturing solutions for drugs, protein-based biologics, cell and gene therapies, vaccines, and consumer health products," according to its most recent annual report - has been on something of a roller coaster ride.
Catalent went public in 2014, raising >$800m via the issuance of 42.5m shares priced at $20.5 per share, and the stock currently trades at $43 per share, so long term shareholders can be well satisfied with their return on investment of ~115%, which almost exactly matches the return of the S&P 500 over the same period.
Catalent share price vs S&P 500 since IPO (TradingView)
With that said, as we can see above Catalent shares traded at a peak value of >$135 in October 2021, and >$110 as recently as July 2022 - up >450% since IPO - before embarking on a crushing bear run to <$45 in a little under six months.
Catalent income statements since IPO (Seeking Alpha)
The bear run may seem all the stranger when we consider Catalent's historic financial performance. As we can see above, the company has grown revenues, operating income, and net earnings in almost every year since listing. Revenues grew by 29% year-on-year between 2020 and 2021, and by 20% between 2021 and 2022.
Gross profit increased by >20% between 2021 and 2022, and operating income by exactly 20%. These are not the kinds of numbers that usually trigger a near 60% decline in the share price.
Catalent's market cap valuation is currently ~$7.76bn, which gives the company a price to sales ratio (based on 2022 revenues) of ~1.6x, and a price to earnings ratio of ~15x - figures that also make a strong case that the business is undervalued.
Current assets are $2.7bn - $345m of cash and short-term investments, $1.4bn of receivables and ~$750m of inventory - while current liabilities are $943m, and long term debt stands at $3.9bn - a little high, perhaps, but not excessive or unusual for a company of Catalent's size, and especially not for a company as profitable as Catalent has traditionally been.
Bearing all of the above in mind, should investors now consider Catalent stock a strong buy opportunity?
Falling COVID Revenues And Manufacturing Issues Stymie Progress
The reality is that Catalent's share price perhaps grew unnaturally high during the pandemic. In 2022, Catalent's President and CEO told analysts on the company's fiscal Q223 earnings call , Catalent earned $1.3bn in COVID related revenues, and in FY21, the figure was ~$850m, as Catalent played an important role in helping to manufacture and deliver >1bn COVID vaccine doses, primarily at the company's Bloomington campus and its 300,000 square foot facility in Anagni, Italy.
The forecast for COVID revenues in FY23 - despite being upgraded by management when announcing fiscal Q223 earnings - is for only $600m, and as a result, as we can see below, Catalent's overall guidance for 2023 was for lower than 2022.
Catalent FY23 guidance (Catalent earnings presentation)
Companies that are forecasting for shrinking revenues and income rarely experience rising share prices, although looked at objectively, the 2023 guidance seemed to be far from disastrous - the forward price to sales ratio based on the midpoint of guidance is 1.6x, and the forward price to net income per share is 13x - barely a downgrade from 2022.
In 2024 the likelihood is that COVID related revenues will shrink again, and the like-for-like comparison of Q223 versus Q222 is unflattering, as shown below.
Catalent Q223 vs Q222 earnings performance (Catalent earnings presentation)
Furthermore, news of "productivity issues" at three of its major production sites and that Chief Financial Officer Thomas Castellano was stepping down, announced in April, saw Catalent's share price take a nose dive, after rumors that the company may be acquired by $180bn market cap Life Sciences giant Danaher Corporation (DHR) had seen Catalent's share price finally gain some momentum, climbing to a high of $67 earlier this month.
The Danaher Buyout Rumors
In April, Barclays downgraded Catalent stock citing concerns around the outlook for the company in 2023 and 2024, but maintained a price target of $70, while Deutsche Bank actually raised its price target to $88, suggesting that the company could outperform this year.
Both Barclays and Deutsche may have been swayed by the M&A rumors that Danaher wished to make a bid for Catalent, but these rumors were seemingly quashed last week, according to a Bloomberg report .
Analysts had discussed a deal taking place at a substantial premium to Catalent's traded share price - analysts at Jefferies for example had speculated that a deal could be done at a price of $93 per share, which represents a premium of >115% to current traded price.
Whether Danaher was put off by Catalent's April updates is unclear - the takeover rumors may not have been concrete anyway - but it's fair to say that FY23 guidance may now be downgraded when the company reports its Q3 results in May.
Downgraded Guidance Almost Inevitable When Q3 Earnings Are Released In May
In its press release , the company states that it expects that "productivity issues and higher-than-expected costs" will:
... materially and adversely impact the Company's financial results for the third fiscal quarter and its outlook for the remainder of the 2023 fiscal year.
The issues relate to Catalent's gene therapy manufacturing site located in Harmans, Maryland, where plans to increase capacity have been delayed, which management says will affect revenues in Q3 and Q4, while the Bloomington facility and another in Belgium are also experiencing higher costs and slower productivity.
At this stage we don't know how bad the problems are and what the impact on revenue will be, but we do know that all three plants are an essential part of Catalent's business. For its part, Catalent says it expects to have the problems resolved by the second half of this year, which represents the first half of Catalent's 2024 fiscal year.
Would A Missed Earnings Beat Be So Disastrous For Catalent? Reasons To Be Cheerful
Catalent operates in a competitive industry, with larger rivals such as Danaher itself, Thermo Fisher ( TMO ), IQVIA ( IQV ), and West Pharmaceutical ( WST ), therefore any drop off in Catalent's performance could easily result in lost business.
With that said, however, Catalent - even without its COVID impetus - always seems to have maintained an impressive client roster, and recent wins such as a long-term partnership with messenger-RNA giant Moderna ( MRNA ) and Sarepta ( SRPT ) - a company whose PDUFA date in relation to a breakthrough Duchenne Muscular Dystrophy ("DMD") gene therapy arrives next month - help to future-proof the business, even if the short-term outlook looks grim.
Catalent does reveal in its 2022 10K submission that one customer "represented approximately 24% of its aggregate net trade receivables" and that another represented ~11% - the former company may well be Moderna given its COVID vaccine - but Catalent has not warned that it's in danger of losing clients, and so long as its manufacturing issues are resolved this year, that ought to prove the case.
According to an investor presentation , Catalent works with almost 8k products, and offers a very broad range of services from drug development all the way through to commercial product. In fact, the company says it has doubled its addressable market in recent years, and will have a total addressable market ("TAM") of ~$100bn by 2027.
Catalent TAM projected (Catalent presentation)
Catalent addressable market growth (Catalent presentation)
Ordinarily, I'm not necessarily keen on companies using TAM as a means of showing how big they can grow - and it also should be noted that Catalent announced a restructuring plan in February aimed at reducing its headcount by 700 staff - but this is an industry with relatively high barriers to entry and now in which Catalent is entrenched, even if there are larger fish in this particular pond.
My overall point is that a company that has generally shown long-term, double-digit percentage point growth at both the top and bottom lines of its business should not necessarily be judged on a couple of poor earnings quarters - as it seems we are about to experience - and management should be trusted to overcome this upcoming setback - based on its long-term outperformance as a company.
With M&A Still A Possibility And Setbacks Priced In, I'm Optimistic Catalent Stock Has Upside Potential
Catalent certainly benefited from a substantial spike in revenues during the pandemic, but even if you take away the additional $850m and >$1bn earned from that source in 2021 and 2022, its business would likely still have outperformed, and grown.
As much as Catalent was likely never worth >$120 per share - valuing it at >$20bn - although you could make a case that a price to sales ratio of 5x is a perfectly adequate way to value a company - my suspicion is that it's not worth as little as <$45 today. Let's imagine a scenario in which Catalent posts fiscal FY23 revenues of ~$4bn, and net income of $300m - a pretty substantial earnings miss. The company remains profitable, trades at very reasonable multiples, and may well have overcome its temporary setbacks.
Added to that, a larger life sciences company - Danaher, or even Thermo Fisher or IQVIA - may feel that if Catalent stock drops any further it would be an ideal time to make a bid for the company and it's very difficult to see such a transaction taking place at a <$10bn valuation, given Danaher paid $9.6bn for a 600-employee contract manufacturer, Aldevron, in 2021. As such, in that scenario, upside is virtually guaranteed.
Catalent is far from a perfect company. Its CEO is relatively new, its chief financial officer recently departed, three of its manufacturing plants are underperforming, and guidance will almost certainly be missed in 2023. But Catalent has faced similar problems before - for example, losing the exclusive contract to manufacture Novo Nordisk's ( NVO ) weight loss "wonder drug" Wegovy due to more "productivity issues" - and managed to recover.
What I would take from the current situation and the Wegovy debacle is not necessarily the view that Catalent is a terrible company, but that the jobs that it takes on are difficult, and that there are not too many companies in its field that can necessarily do a better job. Catalent continues to manufacture Wegovy after all, which promises to be a highly lucrative contract going forward, given analysts believe it may drive revenues in excess of $25bn per annum.
For this reason, and the others I have discussed above, I suspect Catalent can emerge from a difficult period and prove to the market that its weighing machine may be experiencing its own issues when it comes to evaluating the company's worth. My feeling is that Catalent's true market cap valuation ought to be much closer to the double-digit billions.
For further details see:
Catalent: A Promising Upside Opportunity In Play Despite Current Woes