Company Spotlight - Charles River Laboratories (NYSE:CRL)

  No Cage for the Rat Rage

• The Good: Industry leadership
• The Bad: The stock is up 50% in a year
• The Beautiful: End-to-end provider, nice margins

January 15, 2008 - Let's get the biggest potential negative out of the way first, though not everyone sees it as such: this stock soared last year, in fact, it's soaring to new all-time highs now even as the rest of the market is dipping and diving like Red October.

Charles River Laboratories (NYSE:CRL) is the leading provider of animal research models to the global biopharmaceutical industry. In other words, it breeds rats for drug research. This is big business, demand from the pharmaceutical and life sciences industries has service providers like Charles River on a strong growth trajectory these days.

Charles River dominates the market for research models and seems to have an ideal position to leverage across other clinical research areas. The rat business has fat profits. CRO is by nature a lower-margin business and the company continues to make smaller acquisitions in this area, so the margins are going to be going in the wrong direction for a bit. Nonetheless, by most accounts Charles River picked up Inveresk for a reasonable price and operating efficiencies give it better leverage across a larger market.

The story is far from perfect. The company had a rough 2006 when it disappointed with earnings, and the stock plunged from the $50 area to less than $35. CRL has climbed back to $68 now and it seems like investors are keen as ever on this unique franchise.

This is one of those behind-the-scenes companies that most people never know about outside its industry. Charles River is a large and fast-growing company that merits attention from investors. The 8,000 employee firm boasts a customer base that, in its own words, "includes all of the major pharmaceutical companies, biotechnology companies, governments and many hospitals and academic institutions." The company is expected to report earnings per share (EPS) of $2.59 for 2007 (up from $2.20 last year) and $2.95 next, and deliver a 5-year EPS growth rate of 14%.

Since the Inveresk acquisition, Charles River has reorganized into three business segments: Research Models and Services, Pre-Clinical Services, and Clinical Services. This reflects the end-to-end coverage of the drug development process that this company now provides. The company invested $200 million last year in capital expenditures toward its pre-clinical business capacity. Pre-clinical services is Charles River's biggest source of growth, and also where the company dominates the competitive landscape.

The drug industry fell out of favor in 2005, but the push for safer and more effective drugs is as strong as ever and many of the big biotech companies are doing very well. Demand for research animals and the general trend toward outsourcing point to Charles River as a natural way to be invested in the biopharmaceutical business without the risks associated with specific products, as the Vioxx disaster and others remind us.

After the earnings misses in 2006, CRL needed to restore credibility with investors. Sure enough, it has met or beat the consensus for the past five quarters and the stock is up 30% since we wrote about it in September and just set new all-time highs. Momentum-style buyers might like the sound of that, while other investors may want to wait for better entry points. It seems even a down market isn't providing those, though.

The stock is hardly a value investor's dream at 23 times 2008 earnings estimates and 3.9 times sales. This company is a picks-and-shovels play on the biopharmaceutical industry, though, with impressive profits and solid growth potential. If Charles River can maintain investor credibility and keep profit margins from eroding too much in the CRO business, the rat race may be the recession-proof growth story that keeps attracting investors in any market.

- James Hale