- Earnings quality and resiliency were on full display last quarter for IQVIA.
- The company continues to compound FCF at a long-term geometric average of 23%, with equally as high FCF ROE.
- We believe there is a mispricing opportunity to the upside and are seeking a return objective of $254.
- Here are the moving parts of the IQV investment debate.
Investment summary
Investors should be focused on stepping up in quality and resiliency in H2 FY22 for portfolio construction. Names such as IQVIA Holdings Inc. ( IQV ) continue to stand out as deeply valued quality plays that display a high affinity to the 'resiliency factor'. This we define as a long-term history of compounding FCF, strong bottom-line fundamentals and a high return on capital.
In that vein, IQV fits the bill and offers substantial upside premium to an estimated fair value of $254 per share. Here we outline the company's most recent earnings as an example of the momentum in these domains. We rate it a buy, with a price target of $254.
Exhibit 1. IQV 6-month price action
Data: Updata
Q2 earnings illustrate fundamental resiliency
Second quarter sales came in strong at $3.5 billion, up ~300bps YoY and ~700bps in constant currency ("cc") thanks to USD strength. Impressively, adjusting for organic growth, it was a period of upside-down the P&L for the company. For instance, IQV realized a ~700bps Covid-related tailwind, winding back $300 million from the same time last year. Ex-Covid, IQV has grown its top-line organically by 16% over the past two years to date. Segmentally, the technology and analytic solutions business contributed ~$1.4 billion, up ~410bps YoY (940bps cc). Meanwhile, R&D solutions printed $1.95 billion and grew 310bps YoY, and IQV says that ex-Covid, this segment grew 22% YoY.
Contract sales and medical solutions ("CSMS") revenue also came in strong with a 570bps gain to $183 million. Down the P&L, IQV printed $457 million of quarterly operating income on a gross profit of $1.2 billion, and it carried this down to more than $168 million in FCF, below average. Nevertheless, TTM FCF is more than $1.5 billion for the name. IQV has normalized FCF conversion to ~$450 million per quarter since Q4 FY19 hence looking ahead, we expect FCF to revert towards these longer-term levels. Moving down the P&L, and pre-tax earnings came in with an 11% YoY growth, and this carried down to ~$3.02 in EPS.
Exhibit 2.
Meanwhile, profitability continued to be a standout feature for IQV in this period. This point adds bullish weight to the risk/reward calculus. On TTM figures, the company recognized an ~11% FCF margin and delivered a ~21% return on common equity (16% at Q2 FY22). This comes to an FCF ROE of 3.1%, below the 3-year normalized FCF ROE of ~8.4%. On TTM values, FCF ROE is 29%, however. As seen in Exhibit 3, the company has outpaced the GICS Industry median on a number of fronts, including profitability at the bottom line.
As investors step up in quality and resiliency, it is these profitability factors that look to shine through. The market has shied away from rewarding top-line growth and is instead focused on bottom-line fundamentals instead. It has compounded annual FCF by ~23% geometrically since FY16 and looks set to continue along this trajectory, by estimation. Moreover, with strength building from bottom-up in the P&L, we are satisfied with IQV's resiliency factor. It also repurchased $590 million of its own shares, tallying the total value of the buyback to $1 billion. It still has ~$1.5 billion authorized under the buyback program, offering investors a sizeable capital return to consider.
Exhibit 3. Profitability characteristics are a standout in the current climate, and these factors are what investors are paying a premium for in FY22
Data: HB Insights, IQV SEC Filings
Importantly, the cost of capital is tightening in most markets whilst liquidity dries up, potentially hurting funding rounds in the healthcare industry. This is a concern for many companies, particularly at the lower end, who aren't equipped with the capital structure or cash flow to obtain capital at a reasonable cost. Unprofitable entities in particular must either turn to the high-yield corporate debt capital markets or complete expensive equity raises at compressed multiples. Meanwhile, IQV has ~45% of its debt facilities in fixed rates, with the remaining 59-60% fixed using swaps. It also has some Euro debt, which may need to be considered as well. However, pushing a 6% ROIC is below its WACC of ~9% and could be lifted up to speed.
Moreover, as capital costs increase, biotech funding is placed at risk. To that point, IQV management provided clear color early in the earnings call :
"Some of you have continued to ask about the impact of biotech funding on the CRO industry. As we have said on several occasions, the recent decline in biotech funding has not had any significant impact on our business. Our exposure to pre-commercial EBPs remains at just over 10% of our backlog. We have not seen an impact on bookings or RFPs, nor any increase in cancellations or delays in clinical trial work from the slowdown in biotech funding. Actually, RFP dollars from the overall EBP client segment continued to grow double digits in the quarter."
Moreover, IQV's clinical business hasn't experienced a year of revenue decline through the last few market cycles, including 2008/09'. Management noted that bookings reached record levels during the pandemic and that many were worried about a "Covid-cliff". In response, it has replaced all Covid-related bookings with new programs that extend across its entire portfolio. As a result, contracted backlog came to $25 million from the quarter - a record for the company. This totals a 50% increase over the past 3 years, management says, with Covid-19 contribution now only ~600bps of this.
From strength this quarter, IAQ updated FY22 guidance and now expects top-line growth of ~7.4%, calling for $14.4-$14.5 billion in revenue. It also bakes in ~150bps of contribution from M&A activity, and may also be impacted from Forex headwinds, management note. Management also forecasts diluted EPS guidance of $10, calling for ~10-13% YoY growth.
Valuation
Shares are trading at ~26x forward earnings and at a small premium suggesting investors are pricing an above-market earnings growth from the company. It trades ~7x book, and this is pricey in a value-driven environment. We'll analyze this later. It also trades at ~27x TTM FCF and investors realize a 3.7% yield on this.
Exhibit 4. Multiples & Comps
HB Insights
It also generated a TTM FCF ROE of ~29%, demonstrating the equity duration for the company is extremely low at ~2.5 years. However, that is IQV's ROE, not ours. We paid 7x the company's book value, meaning our FCF ROE is 4.15%, and equity duration 17.3. In the current climate, a 4% return on equity from FCF on a defensible name is attractive, by estimation.
As a result, we've also identified a mispricing in IQV's equity value as seen in Exhibit 5. If we were to pay 7x book, we'd theoretically be paying $199, suggesting that IQV could be undervalued by 13%. We, therefore, price IQV at $254 per share and see to obtain this return objective.
Exhibit 5.
HB Insights Estimates
In short
IQV presents with the equity risk premia that investors are paying a premium for in FY22. Profitability and return on capital are standouts alongside a long-term history of compounding FCF. It, therefore, brings this momentum into the investment debate whilst lending exposure to the resiliency factor.
We see a value gap to the upside and price IQV at $254 per share, suggesting a margin of safety of ~13% from this defensive name. From the culmination of these factors, we rate shares a buy.
For further details see:
IQVIA: Resiliency And Quality Never Left, Q2 Earnings Evidence The Same