Charles River Getting Back on Course

Management Clarifies Outlook on the Call

Recent guidance was accompanied by a conference call this morning, in which management clarified its top-line forecast for key businesses and slightly lower operating margin assumptions for the full year.

Specifically, the company expects its research models business to show improved mid-single-digit revenue growth with a stabilization in the transgenics segment and the early '07 market return of large-animal models following the recent quarantine. The company is also adding West Coast capacity in research models during '07, which should contribute to '08 results.

On the preclinical side, revenue growth is forecast at a mid-teens pace, with efficiency improvements at mature facilities offsetting a large part of the cost from added capacity. Expansion projects are on schedule in Massachusetts and Nevada for the first quarter of '07 and the summer of '07, respectively.

Building a Better Mousetrap

Charles River Labs competes in three main segments of the drug discovery and development process for major pharmaceutical, biotech, academic and government research institutions. The company possesses a leading market position in research models and services, which provides outsourced rodent and larger-animal models for drug research. The company's current expansion in preclinical research services largely involves growing demand for toxicology studies. The company also occupies a smaller presence in the clinical research operations segment for all phases of clinical development.

Charles River is generally well positioned with stable to improving market demand for its outsourced research models, testing and clinical services businesses. The company has faced larger-than-expected business fluctuations this year but occupies a relatively defensive space as a key service provider to Big Pharma and biotech investments in R&D.

Shares Set to Rebound

CRL shares have been struggling to hold long-term support at the 200-day moving average just below $42. I expect that today's news will enable the stock to hold this level and show renewed momentum in the short term.

The stock also has room for improvement from a valuation perspective, trading at only 16.9 times the midpoint of the revised '07 forecast of $2.48 a share. This forward P/E corresponds to about a 15% discount to the CRO group. Although further volatility may be in store during the first half of next year, I believe the share valuation and earnings performance both contain room for improvement in '07. I therefore expect the stock to reach the $50 level at about 20 times next year's earnings in the not-too-distant future.