Medpace Holdings Appears Richly Valued

I remain cautious in the current environment and am not looking to aggressively (1) initiate new positions and (2) increase my exposure to exiting holdings. Markets operate in cycles and inevitably, a major event or a series of events will trigger a broad market correction. While I do not invest in the broad market, the valuation of companies in which I have exposure, or would like to have exposure, will most likely be impacted if overly aggressive investors rush to the exits. I, therefore, continue to seek out investment opportunities and to place them on my 'Watch List' if they appear to be richly valued. One such company is Medpace Holdings (MEDP).

With the release of its Q4 and FY2023 results and FY2024 earnings outlook after the February 12, 2024 market close, I take a quick look at this clinical research-based drug and medical device development services provider.

Business Overview

MEDP is a global provider (see locations) of clinical research-based drug and medical device development services. It partners with pharmaceutical, biotechnology, and medical device companies in the development and execution of clinical trials. Its drug development services focus on full service Phase I-IV clinical development services and include development plan design, project management, regulatory affairs, clinical monitoring, data management and analysis, pharmacovigilance new drug application submissions, post-marketing clinical support, laboratory services, clinical human pharmacology, imaging services, and electrocardiography reading support for clinical trials.

NOTE: Pharmacovigilance is the science and activities relating to the detection, assessment, understanding and prevention of adverse effects or any other medicine/vaccine related problem.

In this brief video, Dr. August Troendle, MEDP's founder and CEO, talks about the benefits of a full-service Contract Research Organization, also called Clinical Research Organization, (CRO) in clinical development outsourcing.

Full-service CROs provide the end-to-end services necessary to conduct a clinical trial (including project management, site selection and management, data management, biostatistics, clinical monitoring, regulatory affairs, pharmacovigilance, etc.). Specialized CROs, on the other hand, offer a limited range of services or expertise.

There is a broad range of specializations. Examples include a focus on a specific therapeutic area (e.g., oncology, rare disease), service (e.g., data management), phase of development (e.g., preclinical, Phases 1-4), medical product type (e.g., device), and region.

While the company's website provides valuable information, I always recommend investors look at Part 1 of the company's most recent Form 10-K. The FY2022 Form 10-K, accessible via the SEC Filings section of the company's website, is currently the most recent at the time I compose this post.

The following key financial trends provide a quick snapshot of how MEDP has performed over the last few years and what management expects for FY2024.

Financials

Q4 and FY2023 Results

Material related to the February 12, 2024 Earnings Release is accessible here. However, I provide the following for ease of reference.

• ONC: Oncology
• MET: Metabolic
• CV: Cardiology
• CNS: Central Nervous System
• AVAI: Antiviral and Anti-infective
• OTH: primarily Nephrology, Rheumatology, Musculoskeletal, Dermatology, Gastroenterology, and Ophthalmology therapeutic areas.

MEDP generated ~$0.397B of free cash flow (FCF) which contributed to cash and cash equivalents increasing to ~$0.245B at FYE2023 from ~$0.028B at FYE2022.

It repaid $0.05B of short-term debt during the year and had no borrowings at FYE2023.

Operating Lease Right-of-Use Assets total ~$0.145B of which ~60% or ~$0.085B are related party assets.

On page 73 of 92 in the FY2022 Form 10-K, it is disclosed that MEDP has entered into operating leases with either the company's CEO and/or with the CEO and certain members of his immediate family for real estate occupied by MEDP.

MEDP also incurs expenses for travel services for company executives provided by a private aviation charter company. MEDP's CEO controls the private aviation charter company.

MEDP also incurs travel lodging and meeting expenses at The Summit Hotel. This hotel, located on the MEDP campus, is owned by MEDP's CEO and is managed by an unrelated hospitality management entity. MEDP paid an insignificant amount for travel lodging and meeting expenses in FY2023.

At FYE2023, MEDP had ~$1.1B of total liabilities. Advanced Billings accounted for ~$0.56B; this represents cash received from customers, or billed amounts per an agreed upon payment schedule, in advance of services being performed or revenue being recognized.

Certain executives and employees of MEDP, including the CEO, are members of CinRx’s, a biotech company, board of managers and/or have equity investments in CinRx. MEDP has entered into a business relationship with CinRX re: the performance of clinical trial related services. A very, very small component of the Advanced Billings is from CinRX.

Accrued expenses of ~$0.293B are the second largest liability. The FY2023 Form 10-K is currently unavailable, however, using the Q3 2023 Form 10-Q, we see ~$0.265B. Of this amount, ~$0.184B was Project Related Reimbursable Expenses meaning MEDP will be reimbursed for this amount. Employee Compensation and Benefits of ~$0.07B and other expense of ~$0.011B made up the balance. The percentage breakdown is likely very similar at FYE2023.

Operating Lease Liabilities totaling ~$0.142B at FYE2023 include ~$0.09B owed to related parties.

Free Cash Flow (FCF)

I closely monitor FCF since it provides an indication of what funds are available for reinvesting in the business, debt reduction, share repurchases, and dividend increases.

In FY2015 - 2023, MEDP generated FCF of (in millions) is 79, 78, 85, 141, 184, 227, 235, 351, and 397.

FY2024 Guidance

The following reflects MEDP's FY2024 guidance.

Credit Ratings

MEDP has no debt.

Dividends and Share Repurchases

Dividend and Dividend Yield

MEDP does not distribute a dividend.

Share Repurchases

MEDP’s weighted average diluted shares outstanding in FY2015 – FY2023 (in millions rounded) are 40, 36, 40, 37, 38, 38, 38, 34, and 32.

In 2018, MEDP's Board approved a stock repurchase program. This program has been amended several times to increase the aggregate amount of the stock repurchase authorization. In FY2022 and FY2023, it repurchased $847.849 million and $144.02 million, respectively.

Valuation

MEDP’s diluted PE in FY2016 – FY2022 is 159.25, 54.12, 32.08, 33.76, 42.31, 45.06, and 32.68.

In FY2023, MEDP generated diluted EPS of $8.88. With shares trading at ~$353 as I compose this post, the diluted PE is ~39.8.

Looking at MEDP's valuation from a FCF perspective, it generated ~$0.397B of FCF in FY2023. The weighted average diluted shares outstanding was ~32 million thus giving us a FCF/share value of ~$12.4. Divide ~$353 by ~$12.4 and we get a P/FCF value of ~28.5.

Management's FY2024 guidance is for $10.18 - $10.87 of diluted EPS thus giving us a forward diluted PE of ~32.5 - ~34.7.

Using current broker estimates, MEDP's forward adjusted diluted PE is:

• FY2024 – 6 brokers – mean of $9.96 and low/high of $9.75 – $10.15. Using the mean estimate, the forward adjusted diluted PE is ~35.4.
• FY2025 – 6 brokers – mean of $11.84 and low/high of $11.37 – $12.32. Using the mean estimate, the forward adjusted diluted PE is ~30.
• FY2026 – 3 brokers – mean of $13.83 and low/high of $13.29 – $14.35. Using the mean estimate, the forward adjusted diluted PE is ~25.5.

In FY2022 and FY2023, the FCF conversion ratio was 114% and 109.4%, respectively. Suppose, MEDP generates a FCF conversion ratio of ~112% in FY2024. Using management's FY2024 $10.18 - $10.87 diluted EPS guidance, FY2024's FCF should likely end up at ~$11.4 - ~$12.2. Divide ~$353 by these values and the forward P/FCF range is ~29 - ~31.

Final Thoughts

MEDP has no debt, is profitable, generates strong free cash flow, and its outlook is favorable.

In addition:

• MEDP's CEO & Chairman of the Board (August Troendle, MD), owns ~23% of the company. At the time I compose this post, Troendle ranked #1156 on Forbes' Real-Time Billionaires List. He is obviously doing something right!
• Troendle and/or family members own some of the buildings from which MEDP operates. In essence, Troendle has a considerable vested interest in MEDP's success meaning his interests are closely aligned with those of long-term shareholders.

I am, however, reluctant to initiate a position in the FFJ Portfolio. The odds of generating an attractive total investment return do not appear to be in my favor given the current and forward valuations. We appear to be experiencing a period of irrational exuberance and a sudden broad market pullback is a very real risk. I am simply placing MEDP on my 'Watch List'.

I wish you much success on your journey to financial freedom!

Note: Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected].

Disclosure: I do not currently have exposure to MEDP and do not intend to initiate a position within the next 72 hours.

Disclaimer: I do not know your circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decisions without conducting your research and due diligence. You should also consult your financial advisor about your specific situation.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.