Wuxi PharmaTech Inc (WX) - Drug Services Enhancing Performance
While the news flow for domestic drug companies has been fairly slow this year, Wuxi PharmaTech (WX) has been anything but boring for the four full months it has been public. The firm is categorized as a Contract Research Organization (CRO) and serves pharmaceutical companies by conducting research and development of medications, or manufacturing compounds necessary in the production of different medical treatments. In fact, Wuxi now boasts 9 of the worlds top 10 pharmaceutical companies are customers. As a China based operation, WX is able to capitalize on lower labor costs while still maintaining a level of quality due to the emerging well educated workforce in China.
The company’s stock has declined some since the last time I covered the fundamentals, but closer review will uncover the fact that the stock fell mostly in sympathy with the overall Chinese stock market as evidenced by the decline in the FTSE/Xinhua China 25 Index (FXI). While the company is not immune to macro forces which have led to volatility in the FXI, the strong cash-flow positive business model employed by WX should allow the company to weather volatile markets and the price swings should give patient investors opportunities to pick up quality companies at discounts due to fear in the marketplace.
The most recent fundamental information on WX comes from the EPS release and conference call which took place in early November. The company reported revenue of $34m which was above consensus numbers and was nearly 78% higher than the same quarter last year. While both the Laboratory Services and Research Manufacturing segments showed growth in the quarter, Laboratory Services continued to make up the largest part of earnings accounting for nearly 80% of revenues. Research Manufacturing still grew revenue over 200% when compared to the same quarter last year which highlights the potential for this segment to contribute more meaningfully to the company’s future prospects.
While it is difficult to fully comprehend the intricacies of the pharmaceutical business, it is very clear that management is striving to offer a more diverse assortment of specialized services to its customers. Not only is the company opening new lines of service within the two broad segments, investments are being made in the form of new facilities expansions which will enable additional capacity for new projects. These new projects have had a slightly negative effect on margins as the depreciation of some of the construction projects has already begun hitting the income statements while the new capacity is not fully online. However, management has laid out a timeline as to when investors can expect certain projects to be completed and the second half of 2008 looks to be a very profitable time with increased ability to service more contracts.
One interesting accounting point to note is that the company experienced a very slight decline in gross margins, but when looking at the complete operating margins, the numbers were continuing to show improvement over last year. Management has done an extremely good job of managing its growth with a tight handle on administrative expenses. While it is necessary to bring on more overhead expenses any time a company significantly increases its operations, WX has been able to realize significant economies of scale by leveraging its revenue growth over a relatively stable overhead expense level. This commitment to organizational efficiency can go a long way in boosting a firms shareholder value.
Financially, the company still continues to be in good shape with an ample amount of cash on the balance sheet. The proceeds from the August IPO are still intact and earning interest as the company enjoys the flexibility of a secure capitalization. When looking at the top investors in the stock, it still appears that there is more of a desire to add to positions than to liquidate which should provide some support for the name. The stock is definitely not cheap trading at over 60 times 2007 expected earnings, but with a strong growth rate, and the proven ability of management to attract a blue chip client base, I have confidence that this name will add to the 100% gains it has already logged since the IPO.
FD: Author does not have a position in WX
