A strange thing happened on Kendle International‘s (NASDAQ:KNDL) most recent quarterly earnings conference call.
An analyst asked CEO-to-be Steve Cutler if he planned to make any significant changes once he takes the company’s reins from current CEO and founder Candace Kendle. Bearing in mind that Kendle had just announced a $9 million loss — its third-consecutive quarter of declining year-over-year earnings — the casual observer may have expected the new sheriff in town to produce a laundry list of actions aimed at bolstering the company’s sagging bottom line.
Viewed in that light, Cutler’s response, which essentially amounted to “Not really” (I’m paraphrasing), seems a bit surprising. What’s more surprising is that Cutler’s strategy seems perfectly reasonable.
Despite its less-than-stellar financial performance, Cincinnati-based Kendle appears poised to return to growth largely due to skyrocketing demand for the outsourced drug development and clinical trial services work provided by contract research organizations (CROs) like Kendle and its peers.
The CRO market is expected to flourish, growing up to 50 percent in the next five years, according to Morningstar equities analyst Lauren Migliore. For Kendle, the prospect of grabbing its slice of that expanding pie seems simply a case of being in the right place at the right time — and it can’t happen soon enough.
It’s been rough going lately for Kendle. Aside from the previously mentioned three straight quarters of falling year-over-year profits, the company’s stock price is about 50 percent lower than its 52-week high. Full-year revenues in 2010 were off 34 percent from 2008. In February, Kendle closed an early stage operations unit in the Netherlands, eliminating 60 jobs.
Nonetheless, things are looking up for the company. Last quarter, Kendle posted a book-to-bill ratio of 1.3, its third consecutive quarter above 1.2. Book-to-bill is a key measure of a CRO’s health, and anything above 1 suggests that a company’s sales are likely headed up. Migliore projects that Kendle’s revenues will grow in the high single digits as the company “benefits from favorable tailwinds provided by increased drug-development outsourcing.”
A Deep-dive Into Specialty Pharma
A specialty drug is a class of prescription medications used to treat complex, chronic or rare medical conditions. Although this classification was originally intended to define the treatment of rare, also termed “orphan” diseases, affecting fewer than 200,000 people in the US, more recently, specialty drugs have emerged as the cornerstone of treatment for chronic and complex diseases such as cancer, autoimmune conditions, diabetes, hepatitis C, and HIV/AIDS.
The reasons why pharmaceutical firms are expected to increasingly outsource their drug development and clinical trials to CROs are numerous. For example, drugmakers need to replenish their pipelines as many big sellers go off patent, meaning they’ll have to invest significantly in development. Further, CROs often have greater expertise than pharma companies when it comes to developing drugs in certain therapeutic areas and deeper experience in running clinical trials in a wide array of geographies.
But in the end, the appeal of CROs to pharma simply comes down to one thing: cost. As long as CROs show they can do drug development cheaper than pharmaceutical firms, they’ll continue to get the work.
Sanofi-Aventis has been one of the leading drivers of the pharma outsourcing trend, so it was no surprise when CEO Chris Viehbacher earlier this month proclaimed, “My goal as CEO is never to inaugurate a new research and development center.”
Statements like that sound like beautiful music to CROs, and help explain why analysts like Migliore are bullish on the industry. “Considering the compelling value proposition offered by the CRO model, we expect drugmakers to outsource an increasing portion of their R&D budgets to a select group of preferred providers,” she wrote.
Certainly that’s good for companies like Kendle, which can ride the coattails of rising drugmaker demand for CRO services to return to profitability. But it also comes with a caveat for the Cincinnati firm — Migliore doesn’t consider Kendle among the industry’s “preferred providers.”
That distinction goes to bigger competitors like Quintiles, Icon (Nasdaq:ICLR), Covance (NYSE: CVD) and Pharmaceutical Product Development (Nasdaq:PPDI).
So while things are looking up for Kendle, the company still has a long way before it breaks into the same conversations as the big guys.
“Kendle hasn’t achieved the size that would allow it to compete for the most lucrative contracts,” Migliore said.
