Charles River's Business Outlook - Analyst Blog

Charles River Laboratories (CRL) recently discussed its business outlook with investors and clarified its focus on four key initiatives to drive shareholder value. The company also announced 2011 guidance and made some changes to its 2010 outlook.

The four key initiatives are as follows:

Improving operating margins: The company aims to generate adjusted operating margin of 20% within three-to-five years, which will be driven by cost control and operating efficiencies. The company pegs the Research Models and Services (RMS) segment margins at or slightly above 30% and Pre Clinical Services (PCS) margins in the high teens.

The expected improvement in PCS, however, depends on the extent of recovery in the business that has been affected by low demand from pharmaceutical and biotechnology clients. The company has already taken steps to reduce costs like the November 2010 cost cutting initiative that is expected to cut cost by $40 million in 2011.

The company also intends to eliminate approximately $10 million in combined operating losses from strategic alternatives it plans to pursue for its unprofitable preclinical assets like the Phase I clinic  in Washington state and China preclinical facility.

Improving free cash flows:The company does not intend to incur any major investment for capital expansion as it believes it has sufficient capacity to generate revenue growth. Charles River believes that improved operating margins together with minimal capital expansion will help it generate strong free cash flows. The company expects the total amount of free cash flow to be in a range of $150 million to $170 million in 2011.

Investment in growth businesses:The company aims to invest capital in existing businesses that have the potential to generate maximum sales growth and profitability, such as Discovery Services, In Vitro products and Biopharmaceutical Services.

The company believes combined sales of these three businesses will grow at approximately 4% to 6% in 2011 with an operating margin slightly above the 30% RMS segment level.

Returning value to shareholder through share buybacks:The board of directors of Charles River has authorized a $750 million stock repurchase program of which the company aims to complete the initial $500 million by the end of 2011. This should help drive the bottom-line.

2010 Guidance

Charles Riverreduced its full year 2010 guidance due to the shifting of the company's Phase I business to discontinued operations. This reduces the revenue guidance by approximately $20 million to a range of $1.115 billion to $1.125 billion from an earlier band of 1.135 billion to $1.145 billion.

Charles River also increased the earnings per share guidance by $0.03, resulting in revised full year 2010 guidance range of $1.88 to $1.93.  The Zacks Consensus estimate for 2010 is $1.88, at the high end of the company's guidance.

2011 Guidance

In 2011, the company aims to achieve adjusted earnings per share of $2.20–$2.40, representing a year-over-year growth of 20% at the midpoint. Earnings growth should be driven by aggressive cost management and a lower share count.

Both the Phase I business and China preclinical facility are excluded from the 2011 guidance. The guidance, however, includes roughly $25 million in increased compensation expense related to merit-based salary increases and performance-based bonuses.

From a revenue perspective, the company expects revenue growth to be flat from 2010 levels. Charles River expects RMS segment sales to increase by 2% to 4% driven by price increases and share gains. However, the PCS segment sales are expected to decline 3% to 5% driven by less specialty toxicology sales in the mix.

Operating margins are expected to improve to at least 17% on a consolidated basis. Both the RMS and PCS operating margins are expected to improve compared to 2010.

Operating cash flow is expected to be in the range of $200–$220 million. Capital spending is expected to be $50 million and free cash flow is expected to be $150–$170 million. The tax rate is expected in the range of 26.5% to 27.5% for 2011.

The Zacks Consensus estimate for 2011 is $2.33, which is within the company guidance range.

Our View

We currently have a Neutral recommendation on Charles River. While earnings will benefit in 2011 from the reclassification of unprofitable preclinical assets to discontinued operations, cost reduction efforts and aggressive buybacks, we are still concerned about the weakness in demand for the company's preclinical services from its large clients.

 
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