Investors Should Reduce Exposure to CROs as Biotech Market Slows: Jefferies

In a recent note, Jefferies advised investors to decrease their exposure to contract research organizations (CROs), especially those concentrating on biotech and early-phase research, in light of decreasing demand in the biotech sector.

The firm has downgraded Fortrea and Medpace Holdings from Buy to Hold, citing increasing financial struggles and budget constraints affecting the industry.

According to Jefferies, CROs are confronting considerable challenges as both pharmaceutical and biotech companies cut their budgets. Analysts highlighted a deceleration in the biotech market, particularly in pre-proof-of-concept stages.

Medpace is viewed as particularly at risk, given that 80% of its revenue comes from small biotech firms. Likewise, Fortrea’s significant involvement in early-phase research makes it more vulnerable to a slowdown in activity.

Jefferies also noted that budget reductions and an increase in bad debts have negatively impacted the intra-quarter commentary from CROs. This indicates that the decline in biotech funding that began in 2022 and 2023 has started to take a more severe toll, resulting in higher cancellation rates and diminished new initiatives.

The outlook for Fortrea appears especially tough, as its growth strategy is largely dependent on increasing revenue to meet margin targets. However, the current market conditions are hindering the company’s ability to achieve its 2025 EBITDA margin goals, with lower bookings this year likely to affect next year’s revenue.

In contrast, Medpace, which managed to grow its revenue despite the downturn in biotech funding in 2022 and 2023, is now beginning to feel the consequences of increased cancellations. Jefferies anticipates that Medpace’s bookings-to-billings ratio for the third quarter will land at the lower end of its expected range, potentially impacting its earnings in 2025.

Ultimately, Jefferies concluded that both Medpace and Fortrea are under valuation pressure as their declining fundamentals clash with elevated valuations compared to their peers. The firm suggests that there could be further downside for both stocks.