Investor Essentials Daily

It’s the backbone of the ongoing vaccine rollout, yet rating agencies understate the value this firm has to offer

Catalent, Inc. (CTLT)
March 10, 2021

Despite this firm’s valuable products and services, especially during the pandemic, rating agencies have an overly pessimistic outlook on this name.

A company so integral in the supply chain processes within the pharmaceutical and biotechnology industry is unlikely to go anywhere anytime soon.

Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.

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Pharmaceutical and biotechnology companies have been pushed into the headlines over the past year, with Americans becoming more familiar with Pfizer (PFE), Moderna (MRNA), and Johnson & Johnson (JNJ).

These names have been in this spotlight as they are on the front line developing vaccines and innovating on treatments to fight the coronavirus.

For any one vaccine or treatment to be approved, a legion of doctors and scientists are required, and this is all before manufacturing and distributing the vaccine. Complex machinery, a robust supply chain, and supporting players are all needed for a smooth rollout.

Pfizer has committed to over 300 million doses of the vaccine alone, which requires partnerships with shipping companies, storage companies, and pharmacies to distribute the vaccine.

For a lot of these processes and pipelines of steps, many pharmaceutical and biotechnology companies rely on the products and services of Catalent (CTLT).

Catalent creates the delivery, development, and manufacturing solutions for various drugs. Essentially, Catalent is the backbone for many of these pharma and biotech companies’ operations.

Despite Catalent’s booming business, credit rating agencies highlight this firm as if it is a high yield name with imminent risk of default.

Specifically, the name receives a BB S&P rating, suggesting over 10% risk of default over the next five years. The firm received a similar grade from Moody’s.

Yet again, the rating agencies have the wrong impression.

Even ignoring its recent surge in demand thanks to the vaccine rollout, Catalent is a more stable company than most investors and financial institutions realize.

Our Credit Cash Flow Prime (CCFP) analysis is able to get to the heart of the firm’s true credit risk.

In the below chart, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

As depicted, there is almost no chance the company is going to default over the next five years, making the ratings agencies’ classification of high yield ridiculous.

Catalent’s cash flows alone consistently exceed all obligations in every year except 2025. Additionally, the firm will have between $1.5 billion to $4.5 billion from 2020 to 2026 in cash on hand, well above the firm’s total obligations. This includes Catalent’s insignificant debt maturities over the next five years.

A company so integral to these supply chain processes within the pharmaceutical and biotechnology industry is unlikely to go anywhere soon.

Using the CCFP analysis, Valens rates Catalent as an investment grade IG4 rating. This rating corresponds with a default rate below 2% within the next five years, a more realistic projection once a holistic understanding of the company’s risk is taken into account.

Clearly, rating agencies such as S&P and Moody’s have their heads buried in the sand yet again.

SUMMARY and Catalent, Inc. Tearsheet

As the Uniform Accounting tearsheet for Catalent, Inc. (CTLT:USA) highlights, the Uniform P/E trades at 40.2x, which is above global corporate average valuation levels of 25.2x and its historical average valuations of 31.4x.

High P/Es require high EPS growth to sustain them. In the case of Catalent, the company has recently shown a 28% Uniform EPS growth.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Catalent’s Wall Street analyst-driven forecast is a 20% and 11% EPS growth in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Catalent’s $104.55 stock price. These are often referred to as market embedded expectations.

Catalent is being valued as if Uniform earnings will be growing 20% annually over the next three years. What Wall Street analysts expect for Catalent’s earnings growth is in line with what the current stock market valuation requires in 2021, but above that requirement in 2022.

Furthermore, the company’s earning power is 2x the corporate average. However, cash flows and cash on hand are thrice its total obligations—including debt maturities, capex maintenance, and dividends. Also, intrinsic credit risk is 170bps above the risk-free rate. Together, this signals a low dividend and moderate credit risk.

To conclude, Catalent’s Uniform earnings growth is above peer averages, and is trading below peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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