The INC Research Pullback Creates A Compelling Entry Point

Jefferies upgraded shares of INC Research Holdings Inc INCR, citing findings from its in-depth survey and industry modelling, which reaffirmed superior early development growth and shined a more positive light on late-stage outsourcing.

As such, the firm upgraded shares of the company from Hold to Buy and raised its price target to $69, suggesting 27 percent upside in 12 months.

The upgrade was premised on the modest late-stage improvement and a compelling risk/reward opportunity.

Compelling Entry Point

Analyst David Windley believes INC Research's recent 8 percent pullback since Sept. 1 provides a compelling entry point. Meanwhile, the analyst noted that management's recent indications of low commercial segment visibility have discounted a negative scenario in the stock.

On the other hand, the analyst pointed out to a more competitive Clinical Contract Research Organization post-inVentiv merger, very strong bookings in the first half of 2017 and improving late-stage macro trends into 2018 as upside case for the stock.

Jefferies said its scenario analysis estimates a 10-percent downside in a bear-case but a 35-percent upside if INC Research executes across clinical and commercial (see Windley's track record here).

Expressing a positive opinion on the outlook for the CRO industry, the firm said it expects the CRO market to accelerate from 5.6 percent in 2017 to 6.5 percent in 2018. Through 2021, the analyst expects the market to grow at a CAGR of 5–6 percent.

The firm noted that survey data indicated a continued increase in outsourcing penetration across both early and late stages. The firm also said the risk of significant in-sourcing that threatened to drag growth into the low-single digits is more remote at this point. That said, the firm said the rate of penetration is moderating.

The firm is confident of a 5–6 percent-outsourcing industry growth but sees a more modest 3-percent R&D growth. The flattening R&D growth requires public CROs to generate incremental growth through outweighing toward faster growing SMid sponsors, expanding the total addressable market through ancillary services or taking market share.

Additionally, the firm noted that a survey revealed a faster growth in early development than late-stage in the near- to intermediate-term as pipelines shift to pre-proof of concept. The firm noted that early development outsourcing penetration remains less mature than late stage.

"Our industry model estimates preclinical growth at a 7.4% CAGR through 2021 compared to a 4.9% CAGR for Ph. II/III," the firm said. "Our industry model also indicates SMid biopharma will continue to become a more meaningful CRO growth driver."

The firm estimates SMid biopharma CRO market to grow at a CAGR of 8.6 percent compared to a 4.8 percent from large.

As such, the firm nudged up its 2017 earnings per share estimates for INC Research from $2.54 to $2.55, while it trimmed its 2018 estimate from $3.08 to $3.07.