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UDG growth set to take off

Recent acquisitions have positioned the healthcare outsourcer well to take advantage of the growth expected in pharma outsourcing
November 3, 2016

The pharmaceutical sector has historically lagged behind others in terms of outsourcing but now, with the industry becoming increasingly complex, that appears to be changing. Competition from small innovative biotechs has recently stifled big pharma's abilities to launch 'blockbusters', while tighter regulatory scrutiny and pressures to lower drug costs have seen many companies turn to outsourcers to help to cut overheads. UDG Healthcare (UDG), as a major player in an otherwise highly fragmented market, looks set to be a big beneficiary.

IC TIP: Buy at 654.5p
Tip style
Growth
Risk rating
Medium
Timescale
Medium Term
Bull points
  • Strong balance sheet
  • Recent acquisition expected to boost earnings
  • Pharma industry outsourcing playing catch-up
  • Drugs packaging regulation driving demand
Bear points
  • High rating
  • Historic resistance to outsourcing

UDG has a strong long-term growth record and acquisitions look set to add to the exciting prospects in its end markets. The company is no stranger to delivering value for shareholders through mergers and acquisitions (M&A). This ability to successfully integrate new businesses creates an excellent outlook for newly acquired STEM Marketing, which was bought last month for an initial payment of £55m, rising to £84m over three years if certain milestones are met. STEM is a leader in the field of commercial, marketing and medical audits, an area where UDG has no current expertise. The business is expected to immediately boost group earnings, and brokers have pencilled in a 9 per cent benefit to EPS in the medium term. STEM is also expected to generate a return on capital employed ahead of the group's three-year target of 15 per cent. Proceeds from two large disposals in April, which are not reflected in the debt figure in our table below, have left UDG with estimated acquisition firepower of €550m (£497m). So shareholders could benefit from plenty more acquisitions over the next few years.

Acquisitions, including the STEM purchase, are helping UDG increase the presence of its drug commercialisation business, Ashfield, in the US, where it has recently won several major contracts. In the first half a third of Ashfield's net revenue came from the region, while the division as a whole accounted for 60 per cent of group profit. Growth in the US is expected to come from the political pressure driving an overhaul in regulation and the resultant complexity in drugs marketing and commercialisation. This is likely to drive many large pharma companies to outsourcers. The breadth of Ashfield's services, means it should win more than its fair share of new business.

The Sharp Packaging division, which accounts for 30 per cent of group profits and makes over four-fifths of its sales in the US, is also primed for substantial growth across the pond for two key reasons. First, serialisation - the tracking and tracing of all prescription drugs through the supply chain - will become a legal requirement in the US from late 2017 and new drugs packaging will be more tightly regulated to prevent the spread of counterfeit products. Second, biological drugs - deemed superior to small molecule drugs created via traditional pharma techniques - demand more complex packaging, which is unsuited to the outdated packaging plants at most big pharma companies. Rather than reinvest in in-house packaging capabilities it is likely most big pharma groups will outsource. Sharp should benefit from a recent investment to boost capacity by 30 per cent, which should also boost its higher-margin sales.

Outside of the US, growth opportunities are most likely to come off the back of a big upswing in new drugs launches. Serialisation will also become a legal requirement in Europe from late 2018 onwards.

Overall, it looks like an exciting time for UDG's end markets, which broker Liberum expect to grow at about 6 per cent a year between 2017 and 2021. UDG's earnings should be able to outpace the market growth and, even before accounting for the potential for further acquisitions, the broker is pencilling a compound annual EPS growth rate for the period of 12 per cent.

UDG HEALTHCARE (UDG)

ORD PRICE:654.5pMARKET VALUE:£1.62bn
TOUCH:654.5-655p12-MONTH HIGH:677p477p
FORWARD DIVIDEND YIELD:1.8%FORWARD PE RATIO:22
NET ASSET VALUE:238ȼ*NET DEBT:39%

Year to 30 SepTurnover (€bn)Pre-tax profit (€m)Earnings per share (ȼ)Dividend per share (ȼ)
20132.0380.726.79.6
20140.7659.519.310.1
20150.9285.527.411.0
2016**1.0093.029.111.8
2017**1.0610833.513.0
% change+7+16+15+10

Normal market size: 2,000

Matched bargain trading

Beta: 0.37

*Includes intangible assets of €436m, or 177ȼ a share £1=1.11

**N+1 Singer forecasts