Fortrea Holdings Inc. (FTRE, Financial) is a leading provider of comprehensive phase I through IV clinical trial management, clinical pharmacology, patient access solutions and other enabling services. The company partners with emerging and large biopharma, medical device and diagnostic companies to drive health care innovation and improve the lives of patients worldwide.
The biotechnology company has made important progress in profitability over the last three years, reporting positive net income in 2021 and in 2022, compared to other biotechnology companies that mostly report net losses.
However, I see two main problems for the company: the valuation seems expensive and there is a lack of revenue growth.
Why invest in biotechnology companies
According to data from Market Data Forecast, the global consumer health care market is expected to reach $322.93 billion by 2028, growing at a compound annual rate of 7.2% between 2023 and 2028. This growth is being driven by many factors, including an aging population, increasing prevalence of chronic diseases and rising demand for personalized medicine.
Biotechnology companies are developing innovative new treatments for diseases, using cutting-edge technologies to develop new treatments for a wide range of diseases, including cancer, rare genetic disorders and chronic diseases. These new treatments have the potential to significantly improve the lives of patients and generate significant returns for investors.
The biotechnology industry is highly innovative, creating opportunities for investors to profit from early-stage companies that develop successful products. It is also attractive to venture capital investors due to the potential for high returns. In 2022, venture capitalists invested $61.6 billion in the biotechnology industry, which was the second-highest amount of investment in any sector.
Of course, there are also some risks associated with investing in biotechnology companies. First, the development process for new drugs is long and expensive. It can take many years and millions of dollars to develop a new drug and bring it to market. This means that there is a high risk of failure.
The regulatory approval process is also complex and time-consuming. Biotechnology companies need to obtain regulatory approval from the Food and Drug Administration before they can market their products. This process can be lengthy and expensive, and it can delay the commercialization of new products.
Further, the biotechnology industry is highly competitive. Many biotechnology companies are competing for a limited market share. This means that it can be difficult to achieve profitability.
Overall, the biotechnology industry is a promising sector with the potential for high returns. However, investors should carefully consider the risks before investing in these companies. Keeping these considerations in mind, how does Fortrea fare in this environment?
Financial performance
Fortrea reported its second-quarter financial results on Aug. 14. The GAAP earnings of 32 per share was beat by 20 cents, while revenue of $793 million was beat by $21.49 million. The stock closed nearly 12% lower at $26.90 on increased volume of 4,929,275 shares compared to the average volume of 2,475,723 shares.
The company reported flat revenue growth for the three months that ended on June 30 compared to the same period a year ago. For the six-month period, revenue of $1.56 billion was lower than revenue of $1.57 billion last year.
However, total costs and expenses seem to be rising, which is not a good thing for profitability. Total costs increased to $759.2 million from $721.9 million a year ago. As a result, operating income declined to $33.8 million from $71.2 million a year ago. It is very hard for a company with declining operating income to present rising net income. This is because net income is derived from operating income deducting interest expenses and taxes. It is no surprise, therefore, that Fortrea reported net income of $28.3 million compared to $66.4 million in the prior-year quarter.
In a statement, Chairman and CEO Tom Pike said, “Fortrea is now an independent CRO, as we successfully completed our spin at the end of June. This independence will allow Fortrea to focus our investments to improve research and delight our customers.”
This is an important moment, but what I understand is that Fortrea plans to invest more in research and development or, in other words, increase the operating expenses, which should add more pressure on its profitability over the next several quarters.
Profitability and revenue growth
It is great to see that Fortrea has managed to turn profitable after reporting a net loss of $359.2 million in 2020. It reported net income of $98 million for 2021 and $192.9 million for 2022.
However, the company has not grown its revenue. After an 18.49% sales growth in 2021 to $3.06 billion from $2.58 billion in 2020, in 2022 the sales growth of 1.26% to $3.1 billion lost momentum.
For the full year, the company expects revenue in the range of $3.03 billion to $3.09 billion, which shows nearly flat or minimal negative sales growth. This is not positive for the stock.
Valuation
What about its valuation? The shares trade at a price-earnings ratio of 168.12, which I find too expensive now. Its price-to-operating cash flow ratio is 707.89, which is also an extremely high value.
Fortrea's price-sales ratio of 3.11, however, is ranked better than 76.7% of companies in the biotechnology industry and well below the industry median of 9.75. The price-book ratio is 1.32, which ranks better than 71.27% of competitors and is lower than the industry median of 2.31.
Outlook
Although the valuation is mixed, I do not have a positive outlook for Fortrea as I am concerned about the complete absence of sales growth and I see profitability declining. On the flip side, after its spinoff, the company now has more freedom to focus on strategic products and ideas to provide shareholder value. The spinoff results may take a few quarters to see any material improvement, so patience is the key.
