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Charles River Laboratories International, Inc. Not Much to Get Excited About; Reducing 2013 Estimates to Midpoint of Range

On Wednesday morning, December 12, Charles River introduced 2013 guidance calling for 2.5%‐4.5% reported revenue growth and earnings per share in the $2.80 to $2.90 range, representing growth of 4%‐7% over the midpoint of the 2012 range. This compares with the roughly 10% growth expected next year by William Blair and the Street. Though guidance suggests that essentially no margin leverage is expected, commentary on the call explained that this is primarily the result of investments related to ramping up strategic partnerships (such as AstraZeneca [AZN $48.90]) and that underlying margin can expand 100‐200 basis points as facility utilization approaches optimal levels. We are pleased to see the increase in revenue which suggests the company is gaining share and executing well, with the prospect of more strategic deals in the coming year. But the lack of significant margin leverage despite better utilization is disappointing and causes us to remain guarded on the stock despite Wednesday’s weakness. We are reducing our 2012 earnings per share estimate by $0.03, to $2.69 (up 5%) and our 2013 estimate by $0.14, to $2.86 (up 6%). We maintain our Market Perform rating.

From a market perspective, we believe little has changed from the most recent conference call in late October. Specifically, we believe pharmaceutical companies remain in a mode of low spending growth and are looking to increase outsourcing to save cost and time. Thus, outsourcing penetration is increasing, but underlying activity remains muted, which has resulted in a stable, but low growth market for both RMS (research models) and PCS (toxicology). Pricing trends in both businesses remain stable (1%‐2% growth in RMS and stable to perhaps slightly increasing in PCS as facilities fill up). Commentary on the call suggested that PCS should grow slightly faster than the 3%‐5% constant‐currency growth for the broader company as strategic deals continue to ramp up and additional opportunities come to fruition.

Given that two facilities are already at optimal capacity (roughly 80% to 85% by our estimate), as strategic deal revenue increases, management suggested that the broader company in aggregate could approach optimal capacity by the end of next
year. We suspect that this is more a function of market share gains at Charles River rather than any appreciable improvement in market demand.

We now project reported revenue growth of 4.4% (down from 5.3% previously), though constant‐currency revenue growth of 4.8% is up slightly from our previous expectation of 4.3% because of some volatility in foreign exchange rates. On an organic constant‐currency basis, we expect growth of 3.0% (up from 2.3% previously). On a segment basis, we project organic growth of 2.0% in RMS and 4.6% in PCS (up from 1.7% and 3.2%, respectively, in our previous model).

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