Solskin
Shares of Charles River Laboratories (NYSE:CRL) have been tumbling amidst concerns about slower growth, margin pressure, and higher interest rates. Consequently, shares have been cut in half from a peak above $450 per share in September last year, now settling at $242 per share after recently even trading briefly below the $200 mark.
My last coverage dates back to April of this year, when I concluded that Charles River was steady, solid and growing. At the time the company announced another bolt-on deal, as a 26 times forward earnings multiple looked more compelling (than it did before) as I was waiting for a more attractive multiple amidst higher interest rates.
The Business
Charles River is a $3 billion drug discovery, nonclinical development and manufacturing business. The global business employs over 20,000 workers to facilitate biotechnology and pharmaceutical companies, as well as academic, government and related clients with its services. The business is tilted a bit to North America, accompanied by operations in Europe and smaller operations in Asia. Discovery related revenues make up for the remainder of revenues, about two thirds, accompanied by a research model and manufacturing segment.
A positioning to growing segments and bolt-on M&A have been the driver behind the long-term growth and shareholder value creation. The company generated $2.9 billion in revenues on which it posted earnings of $8 per share (on an adjusted basis) in the year 2020. With 50 million shares trading at $300 early in 2021, the company was awarded a steep $15 billion valuation, or nearly $17 billion if one factors in net debt of $1.7 billion at the time (early in 2021).
Ever since the company guided for growth in 2021, as the company announced a $875 million deal for Cognate Biosciences in the meantime. The company furthermore acquired CRO business Retrogenix in a $48 million deal and Vigene Biosciences in a $292 million deal, the latter deal in order to grow exposure to gene therapies.
As it turned out, strong organic performance made that 2021 revenues did rise by 21% to $3.54 billion, with adjusted earnings up 27% on the year before to $10.32 per share, of which about half a dollar excluded with regard to stock-based compensation expenses.
With earnings seen around $10 per share and net debt of $2.2 billion working down to a 3 times leverage ratio, it looked like smooth sailing, certainly as 2022 sales were set to rise by another 14% (at the midpoint) with earnings seen between $11.50 and $11.75 per share, for a 26 times forward multiple. With shares trading at $250 in April this year I saw appeal rising, just not yet seen. This came as the company announced another bolt-on deal, this time acquiring Explora BioLabs in a $295 million deal.
I concluded to become a buyer around a 5% earnings yield, equivalent to 20 times earnings, or about $200 per share, levels which we saw recently in September, as I picked up a small position at that level.
And Now?
Since September, shares have seen a huge recovery as shares hit the $250 mark again in recent days and weeks. In August, Charles River posted a 6% increase in second quarter sales to $973 million as adjusted earnings rose a similar 6% to $2.77 per share (on an adjusted basis). The company cut the midpoint of the full year sales guidance from 14% sales growth to 10%. Half of this 4% reduction in the sales outlook was attributed to a strong dollar, with the other part being due to general softness of operating performance. The company cut the full year earnings guidance by $0.80 per share to $10.70-$10.95 per share.
The third quarter results were quite solid with third quarter sales up 10% on a reported basis to $989 million, despite intensifying currency headwinds. That strength came at a price as adjusted earnings were actually down seven cents to $2.63 per share, as the predictability of the business is a bit under pressure.
Continued capital deployment, mostly in the form of VC investments and bolt-on M&A, has resulted in net debt inching up to $2.75 billion, albeit that leverage remains intact. Net debt will come down in a minimal fashion as the company has reached a deal to divest its Avian Vaccine business in a $170 million deal. This deal cuts full year sales by around $80 million and non-GAAP earnings by $0.35 per share (or about $18 million) as the deal tag looks a bit cheap, albeit that earn-outs could increase the price tag to about $200 million following a potential earn-out next year.
Following a solid third quarter, the company hiked the full year sales guidance by half a percentage point to a midpoint of 10.5% on the back of stronger operational performance, as the company hiked the full year adjusted earnings per share guidance by five cents to $10.875 per share.
Concluding Remarks
With stock-based compensation trending around $1.30 per share this year, realistic earnings come in around $9.50 per share. With shares back to $242 per share again, Charles River now trades at 25 times earnings, after the multiple briefly dropped to 20 times this summer.
Having taken a small stake at $200 in September, when shares even hit the low $180s at the time, shares have seen a spectacular rebound. Trading at $250 in recent days, shares rallied 25% from my entry point and nearly 40% from a low of $180 per share. This is a huge move given the short period of time which we are considering and the relative defensive nature of the business.
Given all these developments, I am tempted to take some profits here, albeit that I think that the $200 mark was a great long term entry point, yet the speed and extent of the recovery in recent weeks makes it tempting to recycle some money for still further beaten-down stocks.
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