Covance Advances

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A few months ago, I wrote that contract research isn't a one-size-fits-all business. Covance (NYSE: CVD) proves that point.

Covance unveiled a second-quarter report Wednesday that shines among the more equivocal or downbeat recent announcements by peers Pharmaceutical Product Development (Nasdaq: PPDI) and ICON. These contract research organizations, or CROs, conduct clinical trials and provide other services for large drugmakers as well as for small drug developers.

Covance's stock is charging ahead today thanks to the news issued last night. Earnings and revenue beat Wall Street consensus estimates. Plus, Covance raised its full-year forecast in the expectation of a weaker dollar and a lower tax rate. Excluding one-time items, it now predicts an earnings range of $2.60 to $2.80 per share versus $2.50 to $2.70 for all of 2009.

Excluding one-time items, Covance earned $0.66 a share last quarter versus a Wall Street consensus of $0.63 tallied by Reuters. Revenue was nearly 7% higher than the consensus forecast. On a GAAP basis, Covance earned $0.67 per share versus $0.80 for the year-ago quarter. Second-quarter revenue beat the year-ago figure by 5.9%.

Different strategies for different services
Based on market cap, Covance is the biggest publicly traded CRO, followed by Pharmaceutical Product Development and Charles River Laboratories (NYSE: CRL).

Covance appears more optimistic than Pharmaceutical Product Development, which reported expensive contract cancellations during the quarter, and ICON, which just cut its full-year earnings and sales forecast.

CROs serve different niches. Some emphasize late-stage clinical trials. Others focus on animal testing and/or early stage clinical trials. Covance offers a large dose of both services. For the second quarter, revenue and operating income for late-stage testing grew versus the year-ago period while the performance of early development testing declined.

Seeking another niche
Despite recent, severe stock slumps, CROs have thrived as big companies outsource R&D work, a practice that should continue after the mergers of Merck (NYSE: MRK) with Schering-Plough (NYSE: SGP) as well as Pfizer (NYSE: PFE) with Wyeth.

Covance also is working on another way to exploit Big Pharma cost-cutting. On Wednesday, Covance said it would buy a research lab from Merck, adding that Merck will pay $145 million over five years for services related to the study of genes.

Twelve months ago, it signed a deal with Eli Lilly (NYSE: LLY) to buy a Lilly laboratory. Covance will provide development services over 10 years for $1.6 billion, including clinical trials and post-marketing testing of drugs.

Merck also made a deal in December with Pharmaceutical Product Development, which bought a Merck lab and signed a five-year deal to provide vaccine testing and development services. Details weren't disclosed.

In each case, Big Pharma trims costs and signs a long-term services contract. In return, the CRO hires experienced employees, receives a consistent source of revenue, and gains research facilities that they otherwise would have had to build.

It sounds like one prescription – or at least an R&D version of chicken soup – to help CROs recover.

For more Foolishness:

• Greedy? Fearful? Look here.
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• Further evidence that CROs are good medicine for Big Pharma.

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