TD analysis $6.50 target Patheon Inc.
(PTI-T) C$5.51
Turnaround Gains Momentum - Q2/13 Review
Event
We are increasing our target price to C$6.50 from C$4.50 on the strength of continued operating momentum. Patheon’s Q2/13 results were highlighted by strong Revenue and Adjusted EBITDA growth. Q2/13 corporate revenues grew 10% organically y/y to $253.9 million. Adjusted EBITDA increased
$17.9 million y/y to $34.4 mllion in Q2/13 as against Consensus of $31.1 million. The Banner Pharmacaps acquisition closed December 14.
Impact — POSITIVE
The Q2/13 results provided further indication of a turnaround at Patheon. We are increasing our target price and reiterating our BUY rating based on Patheon’s prospects to deliver performance gains in the medium term.
Details
Robust Growth — Transformation efforts showed continued success in Q2/13, as Patheon delivered the fourth consecutive quarter of 10%+ y/y organic revenue growth. Q2/13 corporate revenues grew 40% y/y to
$253.9 million, buoyed by: 1) the Banner acquisition — which contributed $54.6 million in revenues in the quarter; and 2) strong standalone (i.e., organic) growth — 10%. Management attributed the
strong organic growth to several factors, including: 1) new products; and 2) new business wins. To review, CEO James Mullen announced the implementation of a new corporate strategy in September 2011.
? More Efficiencies to Come — The strong revenue growth translated into profitability, whereby Q2/13 Adjusted EBITDA increased $17.9 million y/y to $34.4 million. EBITDA margins grew 446 bps y/y to
13.5% in the quarter. Notably, management disclosed that the EBITDA “flow through” rate on incremental revenue in the base business was 80% in Q2/13. Management attributed the strong performance to volume growth combined with operational efficiencies. Looking forward, we expect several opportunities for cost savings, including 1) synergies from the Banner acquisition — $12.5 million; 2) the wind down of the Olds, Alberta facility — $10 million; and 3) the Caguas closure — $3 million. Management also reiterated its expectations for generating “high-teens” to 20% EBITDA margins over the next two to three years. Nonetheless, we believe that it is premature to incorporate this scenario into our forecasts given the choppy, unpredictable demand patterns and long selling cycles that characterize the CMO business.
Justification of Target Price
We are increasing our target price to C$6.50 from C$4.50, reflecting an 8x multiple on our F2014 EBITDA
estimate of $173 million. We increase our multiple from 6x to reflect the potential for sustained growth and
profitability momentum across Patheon’s businesses. Our new valuation multiple approximates the CRO peer group multiple as we believe that Patheon is (for the first time) delivering growth and profitability performance that is in line with that group. In addition, Patheon has the advantage of being an industry leader in a much less crowded, less competitive operating environment.
TD Investment Conclusion
We continue to believe that Patheon is among the best-positioned companies to capitalize on the third-party dosage form manufacturing trend. We are maintaining our BUY rating based on Patheon’s prospects to deliver performance gains in the medium term.