{"id":29751,"date":"2023-06-30T14:44:53","date_gmt":"2023-06-30T18:44:53","guid":{"rendered":"https:\/\/ifintechworld.com\/news\/evotec-rd-customer-growth-not-enough-to-offset-headwinds\/"},"modified":"2023-06-30T14:44:55","modified_gmt":"2023-06-30T18:44:55","slug":"evotec-rd-customer-growth-not-enough-to-offset-headwinds","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=29751","title":{"rendered":"Evotec: R&D, Customer Growth Not Enough To Offset Headwinds"},"content":{"rendered":"
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Investment Summary<\/h2>\n

Selective investment opportunities continue to present themselves at whim in FY’23 for the patient and intelligent\u2013minded investor. In the same breath, many companies have reasonable growth prospects, but the investment criteria simply don’t add up.<\/p>\n

After a 34% 6-month rally, the equity stock of Evotec SE (<\/span>NASDAQ:EVO<\/span>) has caught my attention. I had been watching EVO on the sides after the company <\/span>extended its partnership with Bristol\u2013Myers Squibb (<\/span>BMY) in March. The pair will engage in drug discovery and clinical programs for another 8 years, building on prior work.<\/span><\/p>\n

This is certainly a tremendous vote of confidence in EVO’s capacity\u2013 to fulfil the clinical development pathways for enormous players such as BMY. Considering this is much of EVO’s core offering, I would opine this is central to the investment debate. Further, robust evidence suggests the company is well-positioned to benefit from market crosscurrents in Omics sciences, thereby providing a clear differentiator for those investors positioning against clinical-stage or biological assets. A fantastic overview of the Omics opportunity EVO has is presented by Seeking Alpha analyst, Another Mountain’s Rock Investing, from December last year. The analysis covers all of the salient points you need to know, and then some. I would encourage all to read that report for the most informed investment reasoning [you can see it <\/span>here].<\/span><\/p>\n

Following extensive analysis of all the moving parts in the investment debate, I find there is insufficient evidence to corroborate that EVO is a buy at the present time. This report will cover all of the critical facts for EVO and respective investors, providing additional details in doing so. Net-net, based on analysis of fundamental, sentimental and valuation factors, I rate EVO a hold.<\/p>\n

Figure 1. EVO rally off December ’22 lows<\/p>\n

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Data: Updata<\/span><\/p>\n<\/figcaption><\/figure>\n

Critical Facts in EVO Investment Case<\/h2>\n

EVO claims to possess a distinct advantage over its industry counterparts in identifying novel drug targets. It has been building momentum around this point for some time. <\/span><\/p>\n

As mentioned earlier, in May 2022, EVO expanded its alliance with BMY, covering<\/span> targeted protein degradation for an additional 8 years. The pair will develop a pipeline of molecular glue degraders within the new agreement. The partnership has a deal potential of $5Bn to EVO. The company received an upfront payment of $200mm and the promise of double-digit royalties into the future. It has already received $50mm upfront under this. <\/span><\/p>\n

These are potentially attractive economics. I would strongly suggest, however, that whilst this is a potentially exciting extension of the old agreement \u2013\u2013more so with the prospect of royalties\u2013\u2013 it is essential to acknowledge that the long-term outcomes of these endeavours remain quite uncertain, and that EVO’s investment prospects shouldn’t hinge solely on this agreement. <\/span><\/p>\n

Further, the market’s response to the Omics and BMY updates has been muted, clear indication of the flat expectations on EVO moving forward. Recall\u2013 a firm’s market value is simply all of the known expectations discounted into the price. Hence, flat price action = flat forward expectations. The question we have to answer, is, whether there is reason to differ from the market’s view. To know this, additional fundamental, sentimental and valuation\u2013based drivers must be discussed.<\/span><\/p>\n

1. Financial and Fundamental Drivers<\/h4>\n

EVO posted its FY’22 annual numbers last month, with revenues up 22% YoY, or $133.4mm, to clip \u20ac751.5mm [note: EVO reports in Euros; hence, all figures will be presented as thus to keep standard convention]. The gain surpassed management’s revenue guidance by \u20ac15mm. J.POD printed a 24% YoY growth in turnover, with an average 15% growth across the remainder of the portfolio.<\/span><\/p>\n

Table 1. EVO long-term operating performance [note: all figures are presented in \u20ac, with the exchange rate of 1 USD = \u20ac0.92 at the time of writing].<\/p>\n

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Data: Author, EVO 10-K’s<\/span><\/p>\n<\/figcaption><\/figure>\n

Growth was predominantly driven by strength in the core business, with customers up by 23 to 842 last year. Impressively, it sees repeat business form ~92% of its customer base, up 100bps YoY.<\/p>\n

Despite the growth in unit economics, I’d also point out that FY’22 gross margin decreased by 130bps YoY. You can thank the rising input costs of Just-EVO Biologics’ manufacturing, compounded by reduced milestone contributions to the top line, as the primary reasons for the contraction. Inflation factors like energy prices, raw materials, and logistics expenses further tightened the gross for FY’22.<\/p>\n

This would be an acceptable point in the interim, if it weren’t for the fact that EVO’s gross capital productivity has been on the slide over the last 2\u20133 years to date. As seen in Figure 2, the firm’s gross profitability, defined as the trailing gross profit scaled by total operating assets each quarter, has clipped from $0.14 to just $0.08 as of Q1 FY’23 (TTM figures). This tells me that for every $1 the company has committed to operating capital, it recycles back just $0.08\u2013 simply not acceptable in my investment cortex. You’re getting just 8% gross return on capital, not even close to the market’s return on capital, thus, an undeniable erosion of shareholder value.<\/p>\n

Figure 2.<\/p>\n

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Data: Author, EVO 10-K’s<\/span><\/p>\n<\/figcaption><\/figure>\n

Moving down the P&L, I would highlight the following takeouts to investors:<\/p>\n