2023-05-11 23:09:52 ET
Summary
- In the past year, Charles River (-13.59%) has trailed both the S&P 500 (+4.83%) in addition to the healthcare index, IXHC (+21.81%).
- This reflects a -44.57% YoY free cash flow decline owing to material reductions in net income from 2021-22.
- Increased interest rates and supply chain concerns leading to demand and supply constraints.
- However, as demonstrated by this quarter's earnings beat, Charles River's ability to leverage life science megatrends and leadership across all verticals signal a growth-centric future.
- Combined with a general undervaluation and strong capital deployment strategies, I rate the company a 'buy'.
Charles River Laboratories ( CRL ) is a US-based global life sciences and pharmaceuticals company, with a focus on preclinical and clinical laboratory services, gene therapy, and cell therapy products for pharma, medical device, and biotech sub-sectors.
Charles River Q1 2023 Presentation
These activities have led to TTM revenues of $3.98bn alongside a net income of $486.23mn in the same time period. More impressive are the company's Q1 2023 earnings, with organic revenue growth of 15.4% and non-GAAP EPS of $2.78, both exceeding guidance from the beginning of the year.
Introduction
Leading across all drug modalities- with distinct solutions and capabilities across the small molecule, large molecule, and cell and gene therapy- Charles River offers a differentiated platform, maintaining a diversified client base, and addressing growing industry needs with M&A activity, the firm positions itself for scale-oriented growth.
To achieve these strategic objectives, Charles River segments itself into Research Models & Services, Discovery and Safety Assessment, and Manufacturing Solutions, covering the pharmacological and healthcare industries end-to-end.
Valuation & Financials
General Overview
In the TTM period, Charles River, down 13.59%, has experienced poorer price performance than both the general market, represented by the S&P 500 ( SPY ), up 4.83%, and the industry it operates within, represented by the healthcare index ( IXHC ), up 21.81%.
Charles River (Dark Blue) vs Market and Industry (TradingView)
I see this as mirroring depressed demand due to dual pressure from interest rates and inflation alongside an inability to fulfill backlogs due to supply chain concerns.
However, as evidenced by this quarter's strong earnings beat, many of these issues have since been assuaged.
Comparable Companies
The novelty of the Life Sciences industry has led to perpetual and rapid evolution, meaning that most companies operate with different specificities and capabilities. As such, no two companies are directly competitive, though many are peers; Qiagen ( QGEN ), Repligen ( RGEN ) and Bruker ( BRKR ) all fit this description and are major Life Sciences Tools and Services providers.
As demonstrated above, despite sustaining both the second-highest revenue and earnings growth after Repligen, Charles River has seen the poorest one-year and last-quarter price action. Thus, in spite of a post-earnings rally, Charles River has a long way to go before it approaches fair value.
Said idea is further emphasized by Charles River's superior multiples-based value, with the firms' TTM and forward P/E, PEG, and P/S all lower than competitors. Similarly, the company maintains the second-best ROE and ROA, alongside the highest book value per share, demonstrating the fiscal discipline of Charles River.
Beyond all else, juxtaposing Charles River's position with peers illustrates its sheer undervaluation, especially on a multiples outlook.
Valuation
According to my discounted cash flow analysis, Charles River's fair value should be $228.65, up from $196.53 today, meaning CRL stock is currently undervalued by 14%.
My DCF is modelled with the assumption of a benchmark 8% discount rate, in line with the company's debt-centric WACC. Additionally, I project a net margin in line with historic levels, smoothed out for the volatility of last year and grow annual revenues by 2% a year, for inflation. I maintain a conservative approach to valuation, with the actual CAGR of the Life Sciences approaching 10.8% by 2030.
AlphaSpread's multiples-based relative valuation analysis corroborates my theory of undervaluation, with the tool calculating an undervaluation of 49%, with a fair value of $382.72.
Therefore, averaging out the two values, the actual fair price of Charles River should be $305.69, with the stock undervalued by 31.5%.
Peerless Ability to Leverage Healthcare Trends Through Specialized Portfolio
To secure the business's ability to scale and remain resilient in the face of macro headwinds, Charles River has dedicated itself to significant revenue diversity. This applies to both the firm's segmentation (RMS generates 19% of revenue, DSA 60%, Manufacturing 21%) as well as its client base, with 40% of end-markets involving biotechnology, 30% Globals, 10% Academic/Government, and 20% other. More so than scale, Charles River puts a premium on client quality, with most top 25 clients being biopharma giants, and record client growth over the past few quarters.
The company additionally positions itself to capture the significant growth of the Life Sciences Industry, with a high single-digit to mid-teens growth across every vertical the company operates within. Beyond the company operating in a large number of segments, Charles River has worked towards promoting access to its products, augmenting its digital ecosystem with increased investments; this has enabled more rapid data access for clients, increased automation capabilities, more real-time connectivity with clients, e-commerce sales, and enhanced data and artificial intelligence-driven insight.
Charles River's end-to-end, highly integrated operations enable greater profit recovery going into the future as well as greater potential for upselling consumers to whole suite outsourcing to Charles River. Further catering to the increasingly specialized nature of life science products is the company's disciplined capital deployment strategy, with a focus on inorganic growth. Since 2012, the firm has invested >$4.5bn in over 25 acquisitions; these have included cell therapy companies HemaCare and Cellero in 2020 alongside ExploraLabs, a provider of full-contract vivarium research contracts, most recently in 2022.
Wall Street Consensus
Analysts support my positive view of the company, projecting an average 1Y price increase to $251.62, up 29.08%.
Even the minimum projected price forecasts a 4.14% price increase to a price of $203.00.
This only highlights my pre-existing notion of undervaluation.
Risks & Challenges
Inability to Consistently Innovate & Sustain Leadership
As previously discussed in the article, the life sciences industry is constantly innovating and evolving. While Charles River has taken steps to address this through relationships with venture capital firms and affordable M&A activity, failure to adequately continue to do so may lead to decreased demand for Charles River products and services and ultimately lead to depressed cash flows.
Intellectual Property Security
Charles River's ability to protect and secure its services is core to its value proposition. In case of continuous cybersecurity breaches, the firm risks its entire value proposition and exclusive products becoming less exclusive. This could materially harm the business and its ability to operate effectively.
Poor M&A Could Reduce Operational & Financial Efficacy
As described in the corporate strategy part of the article, Charles River relies on its strength in inorganic capital deployment to be able to capture double-digit CAGR and continuously innovate at a rate comparable to or exceeding the industry. Poor acquisition activity will not only prove costly to the company and further increase a high debt/equity level but can also reduce the company's ability to compete in the longer term.
Conclusion
In the short term, I expect Charles River to carry the momentum of its earnings rally to fair value.
In the long term, I project that Charles River's strength in M&A and revenue diversity will enable it to capture the healthcare megatrends of double-digit growth.
For further details see:
Charles River: Strong Earnings Manifest Life Science Megatrends