Jefferies Highlights A Pair Trade In Pharma: Buy ICON, Hold Tight On INC Research

Jefferies said in a note on Thursday that it's focused on two opposing themes in pharma services, namely slowing outsourcing and revenue growth and consolidation, with the former increasing the need for the latter.

Against this backdrop, the firm highlighted a pair trade in the pharma services sector. Jefferies upgraded shares of ICON PLC ICLR and downgraded shares of INC Research Holdings Inc INCR.

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Analyst David Windley said feedback from industry sources added credibility to the shift away from full-service outsourcing and to slowing growth. The analyst thinks the M&A theme is trumping slowing growth and that ICON is the best way to play this directly.

Jefferies also updated and increased its price target for its pharma services coverage to reflect sector growth and valuations, relative to the market. The firm feels the valuations of late-state contract research organizations, or CRO appear reasonable, despite the slowing industry growth.

"Our updated PTs better reflect the reality that current multiples are sustainable provided the broader market remains healthy," the firm said.

On specific stocks, Jefferies prefers stocks insulated from Insourcing such as Charles River Laboratories Intl. Inc CRL and PRA Health Sciences Inc PRAH, or with M&A optionality such as ICON. Giving reasons for its shift out of INC Research and into ICON, the firm said INC Research has near term integration risk, while ICON has potential for multiple expansion and also for larger M&A.

ICON Favored Due to Valuation And M&A

Jefferies believes ICON offers a more compelling risk/reward over the next 12 months. The firm noted that shares continues to trade at a group discount. Accordingly, the firm sees solid appreciation potential, as Pfizer Inc. PFE concentration is reduced, with potentially 45 percent upside with more aggressive M&A.

On the other hand, Jefferies thinks INC Research's recent merger with inventive, though markedly improving its strategic position, brings with it near term integration risk not fully incorporated into shares.

As such, Jefferies upgraded shares of ICON from Hold to Buy, with the price target lifted to $117. Meanwhile, the firm downgraded shares of INC Research to Hold from Buy, but increased the price target to $64.