The standard healthcare pitch for investing in healthcare stocks contains a number of standard components. Among them are favorable demographics due to an aging global population and the favorable impacts of recent U.S. industry legislation that adds millions of patients into the system. These are definite positives, but there are also unique ways for the major players to cut costs.
Outsourcing business functions is a way other industries reduce expenses, and it is becoming a more important theme in healthcare. And unlikely as it may sound, shifting drug development functions to a third party is really catching on…
A primary reason is because drug companies are under the gun. After years of easy growth thanks to hundreds of blockbuster drugs, the industry has hit a dry patch in terms of finding successful drugs to bring to market. The law of large sizes has also taken hold, as the biggest firms now generate billions in sales — so they need an ever-increasing number of drugs to make an impact on total sales. Finally, many blockbuster drugs are seeing their patents expire, a phenomenon known as “the patent cliff,” after which sales plummet as generic versions are released.
Struggles on top-line sales mean that cost cutting has become ever more important for drug companies to push profits forward. Additionally, medicine is entering a more personalized phase, where genomic profiles are made of patients to better position drugs for success in treating diseases and other ailments.
Overall, it's easy to see why firms may want to turn to Ireland-based ICON plc (Nasdaq: ICLR) for help. The company bills itself as one of the larger contract research organizations, or CROs, which basically means that pharma, biotech and medical device firms outsource some of their research functions to ICON. A key function that ICON handles is clinical trials — it now conducts trials for the top 20 pharmaceutical companies in the world. This is an extreme vote of confidence in ICON's business model.
The clinical trial process consists of four phases to determine if a drug compound has efficacy, or effectiveness in the marketplace. Clinical trials that can take up to six years to complete (there are usually even a few years of preclinical research involved before clinical trials can even begin). Altogether, this means that the entire cycle can take up to a decade to complete.
ICON says the pharmaceutical outsourcing industry first got its start in the 1970s and has evolved ever since as healthcare firms have grown more comfortable in outsourcing some of the most important and confidential functions of the drug development process. The benefit of having a CRO firm do this is because CRO firms specialize in clinical trials and therefore are usually more efficient and cheaper.
ICON is in a particularly fortunate position, as it has grown into one of the largest and most respected CRO firms. Organic growth and a steady stream of acquisitions, including the 2009 purchase of Veeda Labs, have continued since the firm was founded in 1990.
This success is in the numbers. In the past decade, ICON has posted annual sales growth of close to +30% and annual earnings growth more than +23%. Stock prices follow fundamentals over the long haul, so this has resulted in fantastic gains for shareholders during this period.
Growth in the past three and five year time frames have been equally impressive. Profit trends have also become more stable in recent times, as ICON has achieved the scale to start generating impressive cash flow. Free cash flow reached $221 million last year, or about $3.70 per share.
Action to Take —> This is certainly a stock worth considering. Free cash flow levels were impressive last year. If ICON can keep these levels of capital generation and manage only +5% growth in the next five years, then the shares can rally more than +80% from current levels. Growth in the double digit range for the next several years means that shares can easily double. And despite counting most major pharma and healthcare firms as clients, ICON's sales were still under $900 million last year, and therefore have plenty more room to run.
– Ryan Fuhrmann