Catalent Remains Overvalued

What a difference a few years make. Amid the pandemic, Catalent, Inc. (NYSE:CTLT) was flying high, delivering beta to investors. Former President Trump's Operation Warp Speed created a frenzy to supply the world with COVID-19 vaccines. The mad dash to manufacture and deliver vaccines inured to the benefit of companies in the COVID-19 supply chain. While companies like Moderna (MRNA) and Pfizer (PFE) provided the COVID-19 vaccines, Catalent provided fill-finishing services to certain vaccine manufactures, causing its revenue and operating income to spike.

Now that vaccine deliveries have sharply declined, Catalent revenue and scale, particularly for it Biologics segment has suffered. Management is now tasked with cutting costs to offset the loss of scale. The company has experienced a few hiccups towards that goal. In April 2023, company announced the departure of CFO Thomas Castellano. In August, Catalent announced it would be late in filing its annual report for the fiscal year ended June 30, 2023. That said, based on the company's preliminary fourth quarter and fiscal 2023 results, Catalent may have bottomed.

Catalent's Revenue May Have Bottomed

The company's Biologics segment provides development and manufacturing for biologic proteins; cell, gene, nucleic acid therapies, vaccines et al. Pharma and Consumer Health includes the company's Softgel and Oral Technologies, Oral and Special Delivery, and Clinical Supply Services, in addition to products related to complex oral solids and softgel formulations. For the quarter ended June 2023, Catalent reported revenue of $1.1 billion, up 3% Q/Q and down 17% Y/Y.

Revenue for the Biologics segment was $406 million, down 37% Y/Y and down 15% Q/Q. Biologics revenue fell $180 million or 28% due to a sizeable decline in COVID-19 related revenue. This was partially offset by a double digit increase in non-COVID drug product and drub substance. This could be a consistent narrative in the short-term - whether non-COVID revenue can offset the cascading COVID-19 revenue within Biologics.

Revenue for Pharma and Consumer grew 3% Y/Y and rose by 18% Q/Q. Clinical supply revenue rose, but was offset by supply-chain issues related to a key product, and a decline in prescription revenue. Revenue from Metrics Contract Services, acquired in 2022, added 4% to the segment's annual revenue growth. That said, revenue on a sequential basis was up 3%, implying that for now the company's total revenue decline may have subsided.

Margins Weakened

Catalent's margins fell hard Y/Y, indicating just how much of a high-margin business Biologics was when COVID-19 vaccines - and deliveries - were in demand. Gross profit during the quarter was $235 million, down 49% Y/Y. Gross margin was 22%, down from 36% in the prior year period. Gross profit actually bounced over 30% sequentially, while gross margin improved 500 basis points.

Before longs get too excited, the company's EBITDA is somewhat of a puzzle. EBITDA for the quarter was a paltry $18 million, down over 90% Y/Y and down over 90% sequentially. Dragging down EBITDA were $157 million in what the company calls "unallocated costs," consisting of restructuring costs, special items and corporate direct costs among other things. Restructuring costs are related to the company's plans to reduce costs, consolidate facilities and optimize its infrastructure. These costs will likely be ongoing for a few quarters as Catalent attempts to offset its cascading COVID-19 related revenue.

EBITDA margin during the quarter was 2%; sans restructuring costs it would have been about 17%, still off from the 25% EBITDA margin reported in the year-earlier period. That's a long-winded way of saying that while the company's top line deterioration may be subsiding, it EBITDA may not recover anytime soon.

Why CTLT Is Overvalued

Per the company's Q4 '23 earnings call presentation, management's fiscal '24 guidance implies that at the mid-point, the company's revenue could rise 3% Y/Y and EBITDA growth could be flat. Its full-year COVID revenue will fall hard, while non-Biologics revenue could grow in the 30% range. Even if the company hits these marks, its ability to rationalize costs and offset the loss of margin from COVID-19 revenue remains to be seen.

At October 2, 2023, the company had an enterprise value of $12.6 billion. Per management, the company generated full-year EBITDA from operations of $291 million. This equates to an EBITDA multiple of 43x. At the mid-point of management's 2024 "adjusted EBITDA" guidance, EBITDA would be $720 million. This implies CTLT trades at about 18x forward EBITDA. In my opinion, this would still be too robust given the company's growth prospects.

Conclusion

Catalent, Inc.'s valuation is unjustifiable. Sell the stock.