Parexel manages its business in three segments: Clinical Research Services (CRS), PAREXEL Consulting and Medical Communication Services (PCMS), and Perceptive Informatics (Perceptive).
CRS is Parexel’s core business, accounting for 77% of revenues. The CRS segment includes services for all phases of clinical research from “first-in-man” trials, where a drug is tested in a human for the first time, through post-marketing studies after approval by a regulating body. CRS offerings include clinical trial management and biostatistics, data management, clinical logistics, and clinical pharmacology, and related medical advisory, patient recruitment, and investigator site services.
PCMS accounted for 11% of revenues. The PCMS business provides technical and consulting services for drug development, regulatory affairs, and good manufacturing compliance consulting. PCMS also provides market launch, market access, and reimbursement services.
Perceptive accounted for 12% of revenues. Perceptive provides information technology solutions to improve drug development processes. Perceptive’s portfolio of products includes medical imaging services, ClinPhone RTSM, CTMS, EDC, web based portals, systems integration, and patient diary services.
With Parexel providing critical support services to pharmaceutical companies, investors could be forgiven for thinking PRXL is in a great business. After all, drug companies are practically required to do business with Parexel (or one of Parexel’s competitors) because outsourcing clinical research services is usually the most cost effective option and a necessity as part of gaining approval for a new drug. This is evidenced by steadily growing revenue over the past decade.
The problem is that Parexel has no economic moat; it is easy for competition to enter the business. This is evidenced by Parexel’s financial results.
Despite steadily advancing revenue PRXL has had a tough time translating that in to increasing earnings or free cash flow as shown by the two charts below.
Parexel has also earned below average returns on capital and returns on assets.
As we said before Parexel has shown steady revenue growth in the past and it is continuing as of the latest quarter. Backlog increased to $3.44 billion as of June 30. The cancellation rate was 4.2% which is well within management’s target of 3.5% to 5%. The problem with Parexel’s growth is that the company will need to continue to increase expenses and capital expenditures to be able to service the increased size and number of contracts. So, while the company has grown, this hasn’t been very profitable growth.
Parexel’s management is aware of the less than stellar results and has announced plans to try to improve margins and profitability. The company announced it is targeting operating margins of 9% to 10%.
So how likely is that that Parexel is able to achieve its margin improvement goals? Parexel’s main publicly traded competitors are Covance (CVD), Icon Plc (ICLR), and Pharmaceutical Product Development, Inc. (PPDI). As the charts below show, all have operating margins above 10% except for Covance (but they operated above 10% for the last nine years).
With most of Parexel’s competitors showing operating margins of over 10% for long periods of time it seems reasonable to assume management should be able to reach their goal and keep margins up in the 9% to 10% range.
But this does little to address the underlying attractiveness of the business. All of Parexel’s competitors earn average or below average returns on assets and returns on capital as the charts below show.
Additionally, ROA and ROC have been in decline over the past few years for Parexel and their competitors. Although this could just be due to the recession, the fact that we have not seen a rebound yet is worrisome.
Parexel is one company on the Buffett-Munger Screener that investors might want to stay away from.
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Disclosure: Ben Strubel, Strubel Investment Management and its clients have no positions in any of the stocks mentioned.