We have initiated coverage of Pharma-Bio Serv Inc. (PBSV) with an Outperform rating and $4.00/share price target. See below for free access to our full report on the company.
Pharma-Bio Serv, Inc (PBSV), headquartered in Dorado, Puerto Rico and with other offices in the U.S., Ireland and Spain, is principally engaged in providing compliance consulting to the pharmaceutical industry including to pharmaceutical, biotech, medical device and chemical manufacturing companies located in Puerto Rico, the United States and Europe. The company has regularly been recognized as one of the top validation companies in Puerto Rico.
Compliance consulting, which encompasses a broad range of services including regulatory (FDA and international regulatory agencies) compliance, validation, technology transfer, and project management, accounts for approximately 93% of the company's revenue. PBSV also provides information technology services and technical training (~2% of total revenue) and the company has a laboratory in Puerto Rico which provides microbiological and chemical testing services (~5% of total revenue). The company employs about 300 people, many of whom are highly-skilled engineers and quality assurance professionals with advanced degrees in their respective fields of expertise. The company counts many of the pharma "majors" as clients. Their clients include eight of the top ten global bio-pharma companies and seven of the top ten global medical technology companies.
PBSV has grown revenues from a combination of organic growth as well as through acquisitions over the last several years. Increasing awareness among many of the major pharma and medical device companies of the company's reputation as an eminent life sciences consulting firm without the relatively high cost of larger competitors has facilitated organic revenue growth. This has been complemented by small acquisitions since 2006 which has expanded the company's service offerings as well as their geographic footprint.
PBSV's small size has also been an asset, allowing the company to be very nimble and to rapidly adapt to regulatory, industry, market and competitive changes, affording the chance to quickly capitalize on new opportunities. When pharmaceutical activity in PBSV's homeland, Puerto Rico, began to stagnate they were able to quickly focus resources elsewhere which held greater opportunities. This meant entering the European market, initially in Ireland and then branching out to Spain. The U.S. market has been a particular boon for the company, accounting for over 40% of the revenue growth from 2010 to 2012.
A major focus for continuing their recent rapid growth (60% revenue CAGR over last two years) is to take their current capabilities and further expand geographically, in particular to areas of the world that hold the most promise - those with a high concentration of life sciences manufacturing and, preferably which are highly regulated. The U.S. market, with ever-increasing demand for compliance consulting services and where PBSV has already demonstrated early success, is likely where the bulk of the near-to-mid term growth opportunity lies for the company.
Focus Is Running The Biz With Integrity, Not On Investor Relations…
PBSV is somewhat of a rare-bird in terms of their lack investor-awareness activities and borderline shyness of the investment community. There's little question that management's focus is well directed given the company's double-digit revenue growth, double-digit net margins and a rock-solid balance sheet. PBSV's leadership has also placed significant importance on high ethics, integrity, honesty and values - which while maybe not explicitly shown in the income statement columns, almost certainly has contributed to the company's financial performance (via customer retention, repeat business, employee satisfaction, etc). Comb through the corporate website and, based on the amount of space dedicated to ethics, morals, trust and integrity versus that dedicated towards investor relations, it offers a glimpse of where management's priorities lie. Trust, honesty and integrity are characteristics not always present with micro-cap company managements and, coupled with PBSV's impressive financial performance and prospects for continued growth, offers what we believe is a very attractive investment.
PBSV also enjoys a lower tax rate than if they were domiciled in the U.S. As a result of a tax grant awarded PBSV by the government of Puerto Rico, the company is partially exempt from various taxes including Puerto Rico income tax.
The company is in the process of making a more deliberate effort to communicate with the investing public which we expect will provide more insight into the current status of operations and their near-term plans for continued growth. We also think it will confirm that management's lack of investor-awareness activities had everything to do with them spending their energies focused on running the company and running it in the right way, something that we think speaks highly of where their priorities lie and which should provide investors comfort.
Our current financial model, which is subject change, is largely based on recent trends along with some very general "guidance" that the company has publicly disclosed. This guidance includes that the bulk of PBSV's near-term growth opportunity lies with the U.S. market, that growth in Puerto Rico will likely be limited for the foreseeable future and that growth in Europe, while having meaningful potential over the longer-term, may be constrained for a period of time due to the widespread economic weakness.
Our modeled revenue growth (13% 2013, 12% 2014, 10% 2015, 9% 2016) is arguably conservative given PBSV's recent historical financial performance (revenue growth of 76% 2011, 47% 2012). We reiterate that our estimates are subject to change. The majority of our modeled revenue growth is driven by growth in the U.S., with Puerto Rico revenue growth relatively flat to barely positive, and European revenue starting to pick up more meaningfully towards the 2015 - 2016 timeframe. We have incorporated very little expansion in gross margin from current levels - which is also potentially conservative. We look for SG&A spend to remain considerably higher (on both an absolute as well as a % of sales basis) in the current year compared to 2012 as a result of the company beefing up its U.S.-related capabilities and resources. We look for SG&A spend to be leverageable in future periods.
With U.S. revenue increasing as a % of total sales and Puerto Rico revenue remaining relatively flat, the benefit from the low Puerto Rico income tax rate will be lessened. As a result, we model the effective tax rate to increase throughout our modeled periods.
Valuation / Recommendation
Based on our model we look for EPS to grow at a five-year CAGR of about 16% through 2016. We use an industry PE/G ratio of 1.2x to value PBSV. We look for 2013 EPS of $0.21 which values the company at approximately $4.00/share. The stock currently trades at about $1.65, indicating the shares are trading cheaper than fair value. As such we recommend accumulating up to our $4.00 price target. We are maintaining our Outperform rating.
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