Sigh.
I thought I had offered sufficient links and supporting rationale to commend Icon Plc (ICLR) as a worthy investment candidate. Then Saul posted this:
“Now look what happened! There’s a very useful lesson to be gained from this: In 2014 revenue was up by only 11% but earnings were up by 62%. You can get a lot of leverage raising margins by keeping costs fixed, not expanding personal or offices, or whatever they did, and if you are coming off a small base. But then, as revenue barely budged from year to year ($1.50 billion, $1.58 billion, $1.67 billion …that’s year-to-year! Nothing!), the rate of growth of earnings rapidly decreased towards the rate of growth of revenue. That’s life, folks. How much blood can you squeeze from a turnip? You may be able to squeeze a small trade from it on beating terrible guidance, but long term, how far can you go on 5% revenue growth per year? You can only push margins so far, but then you got to grow revenue or nothing grows.”
He hoped we would find his “analysis” interesting. Seriously?
OK, let’s break the facts down in order. First, consider this 5-year chart:
http://stockcharts.com/h-sc/ui?s=ICLR&p=W&yr=5&m…
Anyone here see a trend over the course of the past five years? Of course you do. But let’s dig a bit into the numbers (note: I’ll be presenting financial data from 2013 to 2016). But first, a broad overview:
Founded in 1990, ICON’s core business is the planning, management, execution, and analysis of Phase I to IV clinical trials, ranging from small projects to complex, multinational mega-studies. Through a combination of small synergistic acquisitions and organic growth, ICON’s revenue has increased from $45 million in 1998 (earliest available data) to $1.67 billion in 2016 - an 18-year CAGR of 22% (or ~12% on an organic basis). Though over time this growth has naturally decelerated as the company has grown larger, it’s still above the industry average of 5-7%. [1]
So let’s examine a few numbers (from 2013 to 2016):
TOTAL REVENUE: 1.336M to 1.666M (24.7% increase)
GROSS PROFIT: 490.6M to 705.2M (43.7% increase)
OPERATING EXPENSES: 369.5M to 393.5M (6.49% increase…note, I appreciate this metric bigly, it indicates the company is growing revenues and profits quite nicely while keeping costs/expenses low)
OPERATING INCOME: 121.2M TO 311.7M (157.2% increase…c’mon who doesn’t love this metric?)
NET INCOME: 102.8M TO 262.2M (155% increase…yeppers ICLR more than doubled its income in 4 years)
TOTAL ASSETS: 1,442M TO 1,825M (26.5% increase…note CROs are fairly asset light by nature)
CHANGE IN CASH: 68.5M TO 88.6M (29.3% increase)
Does this seem to be a withering, struggling company to any rational investor? In fact, by well-established norms for management effectiveness, ICLR exhibits the following (on a 5-year average basis):
Return on Equity: 19.5%
Return on Assets: 10.8%
Return on Capital: 16.3%
But…but…Saul just opined this company is in decline based on a cursory review of revenues and earnings from just the past few years!!!
Here’s where I repeat what I’ve stated again and again and again over the years: STUDY THE ANNUAL/QUARTERLY REPORTS!!! Sheesh, we claim to be serious investors, don’t we!?!
So, let’s cast a glance on recent developments that shed light on the modest declines in revenues and earnings. For that, we need to examine the Form 6-Ks (required of Foreign Issuers…ICLR is based in Ireland). Here’s a bit of insight into what the company has done in recent years that has modestly impacted revenues/earnings [2]:
On December 4, 2015, Inclinix-PMG Holdings, Inc (‘PMG’) was acquired by ICON Clinical Research LLC a subsidiary of the Company, resulting in initial net cash outflows of $63.5 million (including certain payments made on behalf of PMG totalling $9.9 million). PMG is an integrated network of clinical research sites operating from 14 metropolitan areas throughout the US. In March 2016, the Company agreed to pay an additional $1.6 million on completion of this working capital review.
On December 15, 2015, ICON Investments Five Unlimited Company issued Senior Notes for aggregate gross proceeds of $350.0 million in a private placement. The Senior Notes will mature on December 15, 2020. Interest payable is fixed at 3.64%, and is payable semi-annually on the Senior Notes on each June 15 and December 15, commencing June 15, 2016. The Senior Notes are guaranteed by ICON plc.
In addition, a serious investor will pay close attention to quarterly earnings reports. If one did that one would have learned that (in 2016Q4):
In quarter four, we achieved gross business awards of $605 million. Cancellations in the quarter, which include the Pfizer bococizumab program, were $171 million. And as a result, net awards in the quarter were $434 million, a book-to-bill of one times. [3]
Yeppers, ICLR had to scrap $171M in backlog because Pfizer’s cholesterol-inhibitor proved to be…well…meh. Stuff happens. But, let’s reflect on this a wee bit. ICLR consistently runs a book-to-bill ratio >1. That means ICLR normally has a booked backlog greater than its burn rate. Pfizer’s cancellation of bococizumab reduced the backlog, but the backlog remains equal to the burn rate. That backlog will grow.
There were other concerns in 2016. Foremost was the expiration of ICLR’s contract for services with Pfizer (its sugar daddy). Pfizer had been a long-term client spanning almost three decades, and a contract cancellation would have been devastating. The share price fell in the months preceding the contract expiration date. No worries, Pfizer renewed its contract and ICLR will be conducting clinical trials on a robust number of pipeline drugs for years to come.
Well, where do we stand? By ALL conventional financial measures, ICLR is a conservatively managed company with excellent metrics. Is there a problem lurking within the CRO sector itself? Nope. Quite the opposite, in fact. As has been reported by many, global R&D spending continues to grow. As I mentioned in my OP, an ever greater number of immunotherapies is entering into clinical trials. And an ever greater percent of the research work is being outsourced to CROs. ICLR is considered to be a premier CRO. The sector is healthy. One might even claim robust. [4]
Soooo…how shall we end this discussion? First, let’s agree that Y-o-Y/Q-o-Q comparisons have limited use when evaluating the LONG-TERM financial prospects of a well-managed business enterprise. It pays to step back and observe the forest rather than the trees. Second, if there’s a glitch in the short-term, the astute investor will investigate the reasons why. Even the best managed companies hit speed bumps. It pays to understand what happened and the ramifications. More often than not, a short-term hiccup presents an excellent buying opportunity. Third, investing is hard work. Read, study, evaluate and act with dispassion. That’s simply what long-term value investors do.
Hope you found this interesting.
[1] http://tinyurl.com/mkfodfz
[2] http://files.shareholder.com/downloads/ICLR/0x0xS1157523-16-…
[3] http://tinyurl.com/mn4oz3y
[4] http://tinyurl.com/mgxfssz