Tuesday, October 28, 2008

Contract Research Organizations Being Taken to Woodshed

It is interesting to watch the bear market come to visit every corner of this market. Up until last week the contract research organizations were one area that were holding up relatively well. Last Tuesday, ICON (ICLR) reported a stellar quarter, reaffirmed guidance ... and it has not mattered one iota as competitors in the space who have reported since have made comments that have caused everyone in the group to suffer. What I love most is how the stronger dollar is used as one of the "problems" for the US based CRO's, and ICON gets hit off that even though they are in Ireland and thus use the Euro - hence should see a tailwind from a stronger dollar/weaker Euro. But in this market everything is thrown together in one big baby in the bathwater trade. In the one week since ICON reported its stock has been pole axed from $34 to $20 despite saying everything right in its own report. We added some last Thursday after a 25% drop to $25. Now it's lost another 20% in the following 3 days. Can't win for losing in this market.

Kendle International (KNDL) and Life Sciences Research (LSR) are the other two we own - neither has reported yet but have been equally smashed based on comments out of Covance (CVD) and Parexel International (PRXL) - I guess everyone is equally guilty even if you reaffirm you are not guilty just last week.
  • Drug makers, it seems, are reining in spending on medical research in an effort to cut costs during the current financial crisis. The companies that do their research for them paid the price for it in the stock market on Thursday. Investors fled the sector after a Covance (nyse: CVD) earnings conference call. The pharmaceutical research company posted relatively positive earnings on Wednesday night. But investors were spooked when the company said that it was suffering from cancellations and delays in research due to funding cutbacks at pharmaceutical companies.

  • Chairman Joseph Herring of Covance said during the call that the credit crunch has stripped many pharmaceutical companies and their under-financed biotech counterparts to push off "noncritical" studies until next year or until financing becomes more easily attainable.

  • A third factor affecting the company has been the strengthening of the dollar against European currencies. Herring said the dollar has gained approximately 18.0% against the British pound and the euro, while it has added about 12.0% against the Swiss franc since the end of the second quarter. This has negatively impacted the company's revenues due to most of its business coming from European companies. (which again should be a plus for ICON - instead it gets punished) These comments caused the whole sector to slide.

  • Parexel International Corp (PRXL) forecast second quarter earnings below market expectations, and cut its 2009 earnings view for the second time in less than two months, sending its shares down 8 percent.

Again, in this market where companies reporting good news, stock buybacks, guidance increases don't react for more than a few hours - and other companies who report better than peer results still get punished based on their peers - there is simply not a way to win on a consistent basis and until the market stops punishing everything in such relentless fashion and some stability returns that lasts for a few weeks it is just a money losing operation to be exposed on the long side to anything.

Long ICON, Kendle International, Life Sciences Research in fund; no personal positions

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