Catalent, Inc.
Moat: 2/5
Understandability: 3/5
Balance Sheet Health: 2/5
Catalent, Inc. is a global provider of development and manufacturing solutions for drugs, biologics, cell and gene therapies, and consumer health products. They offer a range of services, from formulation to supply, to a diverse pharmaceutical, biotech, and consumer health clientele.
Investor Relations Previous Earnings Calls
The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.
Business Overview:
Catalent operates across multiple segments: Biologics, Pharma and Consumer Health, and Clinical Supply Services.
- Biologics: Focuses on developing and manufacturing innovative biologic drugs and therapies, including cell and gene therapies, which is a fast-growing and high-potential area of the market.
- Pharma and Consumer Health: Provides pharmaceutical and consumer health companies with a wide range of services in drug development, clinical trials, production, packaging, and global supply chain management. This segment serves a larger and more diverse customer base.
- Clinical Supply Services: Offers clinical supply services for clinical trials, including packaging, distribution, and returns, to a global customer base.
The company’s core strategy revolves around partnering with pharmaceutical, biotech, and consumer health companies, acting as an extension of their operations to help them produce new and innovative products and manage supply chains.
Industry Landscape & Trends:
- The pharmaceutical and biotechnology industries are highly regulated, complex, and research-intensive, thus generating a demand for specialty CDMOs (Contract Development and Manufacturing Organizations) like Catalent.
- The growth in complex therapies, such as cell and gene therapies, drives demand for specialized production capabilities.
- There’s a trend toward outsourcing manufacturing and packaging as companies look to optimize costs and focus on their core competencies.
- Increased regulation and scrutiny on supply chains are compelling companies to partner with CDMOs that have global presence and compliance capabilities.
Competitive Landscape:
- The CDMO industry is competitive and fragmented, with major players like Lonza, Thermo Fisher Scientific, and WuXi Biologics.
- Competition is based on several factors, including manufacturing capacity, technical expertise, quality, regulatory compliance, innovation, and reputation.
- Many CDMOs are pursuing a strategy of consolidating various specialties (for example, drug formulation with manufacturing and supply chain management).
What Makes Catalent Different:
- Catalent is among the largest CDMOs, which allows them to benefit from scale advantages such as geographic reach, and broad services offerings.
- The company’s expertise in difficult-to-manufacture and complex biologics (including cell and gene therapies) provides a competitive edge and creates a larger potential market.
- Their broad range of services, combined with integrated development, manufacturing, and supply capabilities makes them a preferred partner for larger pharmaceutical companies.
- Catalent is focusing on innovation and creating new technology platforms that create a higher value proposition for its customers.
Financials
Financial Overview: Catalent’s financial performance in fiscal year 2023 was quite challenging due to significant declines in its Biologics segment.
- The company experienced a reduction in revenue and profitability compared to fiscal year 2022 due to the wind down of some COVID-related programs, while the recovery in other areas of the business lagged behind the overall recovery of the economy.
- For the year ended June 30, 2023:
- Revenues decreased by about 5% to $4.2 billion.
- Net loss was $1.0 billion, as compared with net income of $257 million in the prior year
- Adjusted EBITDA declined to $962 million from $1.38 billion in 2022, primarily due to decline in sales of COVID-19 related products.
- For the three months ended March 31, 2024: -Revenues decreased by 1% to $1.021 billion, despite a 7.5% decrease in sales from Pharma and Consumer Health and a 10% decline in selling, general, and administrative expenses.
- Operating loss was $726 million (compared to a profit of $156.8 million for the same period in the prior year) - Net loss was $1.043 billion, as compared with a profit of $140 million in the same period in the previous year.
- The decrease in earnings was driven by a decline in revenue, and also due to goodwill impairment charges of $665 million related to the Biologics and Pharma and Consumer Health segments.
Revenue trends: - The decline in the Biologics segment was driven by the end of COVID-related contracts and slower-than-expected recovery. Meanwhile, the Pharma and Consumer Health segments have continued to show strong growth in drug development, delivery systems, and in the demand for its products. -The revenue decline in the third quarter of fiscal year 2024 was primarily from a decline in sales from Consumer Health, partially offset by growth in the other segments, and also due to the impact of foreign currency fluctuations.
Margins and Profitability:
- Operating margins have been impacted negatively because of decreased volume and higher expenses from inflation, energy costs, and facility start-up costs.
- Profitability will be pressured because the company is transitioning away from the higher margins of COVID-related products.
- The decrease in net income and adjusted EBITDA in the fiscal year 2023 and the nine months ended March 31, 2024, reflects reduced operating performance with lower margins in the Biologics division.
Recent Challenges, Controversies, and Management Response:
- Declining Biologics sales: The end of many COVID-19 related programs and slower-than-expected growth and recovery from the pandemic has resulted in a significant revenue decline in this sector. -Management intends to focus on innovation to attract new business and increase utilization of existing capacity, and believes the business will stabilize with new products in the pipeline. -Management has noted they expect the biologics segment to continue to be challenged for the remainder of fiscal year 2024 and are focusing on cost reduction programs, and restructuring plans to improve profit margins.
- Goodwill Impairment: Due to the weaker sales in the Biologics and Pharma and Consumer Health sectors, goodwill was written down by $665 million. -The company has tried to reassure shareholders that the goodwill write-down is merely an accounting adjustment and does not impact the underlying value of the businesses, or the management’s long-term strategy.
- Restructuring Costs: Catalent is undergoing significant restructuring in its operations which has led to additional costs. -Management expects these efforts to generate long-term efficiency improvements, cost savings and better profitability in the business.
- Debt burden: The company has a high debt load. The management is actively seeking ways to reduce its debt burden and maintain flexibility to make acquisitions. -However, management acknowledges that continued focus on managing operational efficiency and optimizing cash flow are of importance to address its elevated leverage levels.
- Labor Unrest: There were some reports of unionization and labor unrest at some facilities. -Management noted they are working with the unions and intend to improve relationships with workers as well as increase the profitability of facilities.
- Merger with Novo Holdings: Catalent will be acquired by Novo Holdings, which is expected to close in the second half of 2024. This would result in Catalent being taken off the stock market and go private.
Management has acknowledged the recent challenges and are undertaking several efforts to streamline operations and improve performance and reduce costs. However, the success and timeline of these efforts remain uncertain.
Moat Analysis: Based on my review, I believe CTLT has a narrow moat with a rating of 2 out of 5.
- Intangible Assets: Catalent’s brand name and reputation with clients is beneficial, but this is not as strong as pure brand-driven companies. They do, however, have a good reputation in some niche segments, but these aren’t enough to justify a wide moat rating.
- Switching Costs: In certain segments, particularly the Biologics sector, customers may be reluctant to switch to other CDMOs, because of regulations, and quality requirements for sensitive drug manufacturing. However, there are not as strong of switching costs compared to other industries. Some customers may easily change suppliers for more commoditized products and services.
- Cost Advantages: There’s some scale advantage from its large operations. However, the company operates in a highly competitive industry which means price pressures keep the moat from being wide. The company’s lower margins compared to its peers is also something that negatively affects the strength of their cost advantage moat.
- Network Economics: There is limited opportunity for network economics to play a role in this industry.
Moat-Damaging Risks and Business Resilience Several legitimate risks could harm Catalent’s moat and business resilience:
- Operational disruptions and quality issues can be significantly damaging. Problems in manufacturing or quality can lead to loss of contracts, legal battles, and reputational damage with customers.
- Technological disruption is another source of potential risk. New therapies or manufacturing technologies could cause their older investments to lose value.
- Customer concentration: The company derives a significant portion of its revenue from a small group of customers. If one customer decides to pull a business from Catalent, the results will be disastrous for the company.
- Competition: The market is competitive and a large amount of investment required to stay competitive by investing into new technology and production facilities reduces a barrier to entry for new competitors.
- Macroeconomic uncertainty, including interest rate risk, exchange rates, and political risks (specifically in emerging markets) has also put some uncertainty on the company’s future valuation.
- Financial risks: The company faces the risk of having a high debt burden and the need to raise additional capital. There is also risks from fluctuating costs of inputs, such as energy and raw materials, and those fluctuations affecting profit margins.
- Reliance on long-term contracts: The company requires a long time to build and maintain relationships with the company. A lack of success in long-term relationships can affect revenue streams and profitability of the business.
Despite these challenges, Catalent has a fairly resilient business, given its diverse portfolio, global operations, and strong market position. They also provide essential services to the health care industry which implies consistent demand. With their shift to more high value areas like biotechnology should allow them to improve profit margins and increase revenues in the long term. However, their higher leverage makes them slightly more risky than similar companies with low debt.
Understandability: Given the business’s operational complexity and large number of segments, the understandability rating is 3 out of 5.
- It is a difficult to keep track of all of its acquisitions and business segments and to evaluate which one is driving profits and loss.
- The complexity of financial statements due to the number of accounting adjustments in the earnings make it difficult to analyze.
- On the other hand, the basic concept of the company (providing manufacturing capabilities and other solutions) is easy to comprehend.
Balance Sheet Health: Catalent’s balance sheet health is 2 out of 5.
- While their balance sheet shows significant assets, and operating revenues, its debt levels are considered high, which creates a greater financial risk.
- Their debt to assets ratio is at approximately 0.47, which is higher than the ideal of approximately 0.35. Additionally, their debt to equity is also higher than its peers.
- The company has made significant use of intangible assets, which have limited liquidation value, and is not good to rely on for the underlying financial health of a company.
- However, the company is actively taking steps to improve its cash flow and lower its debt levels in the future, and with their shift towards more profitable parts of their business, their financial health may improve.