Jefferies Starts Patheon Holdings (PTHN) at Buy; Sees Broad Platform Leading to Higher Growth
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Jefferies starts Patheon (NYSE: PTHN) with a BUy rating and $32 price target.
Analyst David Windley commented today,
PTHN has developed the broadest set of CDMO services through an inorganic growth strategy. That business portfolio should drive high single digit organic revenue growth, while its "Operational Excellence" quality programs and capacity utilization improvement should grow EBITDA well ahead of revenue.
Other key points offered by Windley with today's initiation:
- Diversified Capabilities in a Fragmented Market. Most CDMOs focus on a narrow market segment: solid dose or parenteral, API or FDF. This results in a fragmented supply chain with few competitors of scale. PTHN has developed an extensive platform of service offerings that span the product lifecycle. Regulatory and quality concerns prompt sponsors to consolidate vendor lists, benefiting large, diversified CMOs, much as that trend benefited large CROs from '09-'14.
- Ample Room for Margin Expansion. We model FY16 adjusted EBITDA margin of 21.4%. PTHN's 49% capacity utilization and OE initiatives support continued margin improvement of ~150 bps annually. In this report, we quantify the margin impact from higher capacity utilization as PTHN adds incremental revenue from its rapidly expanding sales pipeline.
- Operational Excellence: Enhances Quality and Efficiency. PTHN's OE initiative delivered $37.9M in cost savings from FY14-FY16. OE was implemented in FY11 but maturity remains in the middle innings with varying stages at each site. Management is targeting $30M+ in cost savings over the next 2 years. PTHN's historical performance against OE targets gives us confidence in the FY17/FY18 savings targets. By our calculations, OE should account for half of PTHN's projected 150 bps annual margin improvement for those years.
- Inorganic Growth Strategy. In 2012, PTHN began a strategy to gain breadth and scale inorganically. Five acquisitions and five years later, PTHN has developed into a Top 2 CMO by revenue. Management has indicated M&A will remain part of the growth strategy, but we believe this will focus on small, tuck-in acquisitions NT. With high single digit organic growth and high financial leverage (5.6x), we expect FCF to be directed towards debt reduction over transformative acquisitions in the next 12-18 months.
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