To The Charts

Note: this article is for informational purposes only and does not represent financial or any other advice. At the time of this writing, I hold no securities mentioned in this article.

Earlier this week I joined Dan Sfera 's podcast (to be released in coming weeks) to discuss the long-term performance and go-forward outlook for clinical research providers, primarily CROs. I've been doing some chart work over the past few weeks and put some of it to work during our discussion, and this week's newsletter will show where I'm coming from in terms of being optimistic long-term about the prospects of large clinical research providers.

All charts were created on YCharts on 05-Aug-2024 unless otherwise noted.

Biotech and Pharma Equities

Service providers can only succeed over the long-term if their customers are financially healthy. For CROs, their small to midsize biopharma customers must be able to raise capital in numerous stages over many years, and their large biopharma customers need to convert pipeline to product sales to drive profits, fund research for new products, acquire promising small biopharmas, and so on.

A key proxy for the above is the longer-term equity performance of these companies.

For small to midsize biopharma, I like to look at the longer-term chart of the Nasdaq Biotechnology Index (purple line), in this case compared to the S&P 500 composite (orange line):

Next, I look at a chart of the VanEck Pharmaceutical ETF (ticker PPH), which is heavily weighted towards the largest pharmaceutical companies in the world:

My takeaways:

• Small to midsize biotech equities compare well to broader stock market performance over the longer term. They've underperformed the extreme strength in the tech sector over the past year but have been quite strong more recently. The key takeaway, for me, however, is we don't have a long-term issue of small to midsize biotech equities performing so poorly that investors are unwilling to fund them.
• Large pharma is on a strong uptrend in recent years due to successful new therapies hitting the market. Remember that equity prices are a reflection of how what investors expects from companies' future financial performance, so the second chart indicates strong optimism that these companies will continue to perform well, which in turn benefits their suppliers (like CRO) who need them to be successful.
• Overall, long-term equity performance across both segments checks the box for me to feel confident that CROs will have plenty of opportunity to find revenue growth over the coming years.

Biopharma Pipeline and Outsourcing

It's great if biopharma equities are healthy, but CRO revenues are dependent on the size of their customers' R&D pipelines and how much of that pipeline they will outsource. The following chart from ICON's recent Investor Day lays it out nicely:

My takeaways:

• R&D pipeline size has consistently grown year over year, across multiple decades, in good times and bad, with further growth expected in coming years.
• The percentage of that pipeline to be outsourced is also expected to continue growth in coming years.
• The combination of these factors is exactly what you want to see if you're a company providing outsourcing services to biopharma.

CRO Equity Performance

It's great if biopharmas are performing well and expecting to grow the pie from which CROs derive revenue. But do CROs show a history of capitalizing on these long-term trends? This chart shows the longer term share price performance of various key companies I track (excluding Fortrea since it's a relatively new IPO):

The next chart compares the share price performance of the companies above to the S&P 500 (orange line), back to ~2016 when Medpace IPO'd. Syneos Health is included up until it went private in 2023.

My takeaways:

• Every CRO except Syneos has consistently outperformed the broader stock market for at least 8 years, both pre- and post-COVID.
• Industries that consistently outperform the broader economy over the long-term are undoubtedly capitalizing on strong trends moving in their favor.
• When the larger companies in an industry perform this well over a long period of time, it bodes well for smaller industry players to find opportunities to grow their businesses as well.
• I like what I see here.

Revenue Growth Expectations

After reviewing the above, I turn to what industry analysts are expecting for CROs in terms of revenue growth in coming years. This chart below shows 3-year revenue growth expectations from 2024-2026 (Fortrea is now shown as well):

My takeaways:

• The middle 3 lines (Thermo, ICON, IQVIA) reflect that same ~5-6% annual growth rate suggested in ICON's Investor Day slide shown earlier. Medpace is a consistent outlier to the upside, and Fortrea is working through serious post-spinoff issues.
• Overall, the analysts advising the large institutions who invest in these CROs are seeing consistent, favorable revenue growth potential in coming years.

Margins and Earnings

In mature market segments (like CROs), yes I want to see consistent revenue growth and positive future expectations, but I also want to see whether those companies are delivering that revenue at steady, ideally increasing, margins. The chart below compares EBITDA margins (trailing twelve basis) across these companies. I didn't show gross margins here because ASC606 really skews the long-term picture.

Because CROs can get "M&A happy", I also want to see revenue performance translate into continually increasing earnings per share, as a check on whether these companies are truly improving the bottom-line returns that benefit shareholders over the long term.

My takeaways:

• Margins are generally steady and trying to increase, with recent earnings announcements suggesting those margin line might continue to tick up slightly.
• CROs are generally converting revenue growth and steady margins into ever increasing earnings per share, which in turn has been driving the above-market returns seeing in their share prices over the longer term.
• You can nitpick the Thermo line and yes Syneos is a case study in how a rising tide does not always lift all boats, but the positive trend is clear to me.

Putting It All Together

I believe long-term industry trends tell us whether at least the most prominent companies in those industries are finding good growth opportunities, delivering them profitably, and rewarding investors. Anything can change at any moment (the Japanese stock market was crashing the morning I wrote most of this), but those long-term results, coupled with numerous data points suggesting continued growth opportunities, suggest it's a good idea for me to continue consulting for clinical research providers!

And if you're working at a CRO or one of the myriad other service or technology providers in the industry, know that your industry has been providing immense value to biopharmas of all sizes for many years, and is expected to continue doing so for many more.

Footnote: What about China?

Yes the BIOSECURE Act is a huge negative catalyst for China clinical research providers, but the charts below suggest trouble was brewing long before that legislation was introduced: