Recession Schmession, This Industry Is On Fire

No, this isn't an article about how energy or agriculture stocks are on fire. This industry's growth isn't bound by the price of commodities, although it is associated with another business buzz word: outsourcing.

Contract research organizations (CROs) do pre-clinical research and run clinical trials for drug developers on the cheap. With pharmaceutical companies like Wyeth (NYSE: WYE  ) and Schering-Plough (NYSE: SGP  ) cutting back on costs, CROs are in the perfect position to benefit. Just look at the growth some of them have sustained over the past year:

 

1-year return

TTM Diluted EPS Growth

Covance (NYSE: CVD  )

25.5%

24.1%

Parexel International (Nasdaq: PRXL  )

39.2%

38.3%

ICON (Nasdaq: ICLR  )

73.8%

37.8%

Charles River Laboratories International (NYSE: CRL  )

29.2%

22.1%

WuXi PharmaTech (NYSE: WX  )

24.4%*

N/A*

Source: Capital IQ, a division of Standard & Poor's; TTM = Trailing 12-month. Return was calculated through July 30, 2008.*Return from IPO price on Aug. 8, 2007; WuXi's year-ago TTM EPS were negative.

There's something in that list for everyone. We've got a couple of international based stocks in Irish ICON and Chinese WuXi. Covance is the largest coming in at a $5.6 billion market cap while the smallest is WuXi at just over $1 billion.

They range the spectrum of helping pharma at different stages of drug development. WuXi for instance focuses mostly on searching for new drugs and scaling up manufacturing while Charles River will actually run a phase 1 trial for the drug developer. Parexel, on the other hand, can help all the way through post-marketing phase 4 trials. With services like that, it seems possible to set up a virtual drug-developer and just outsource all the research and development to CROs.

The companies on that list do have one thing in common though: Fools love them. All of them sport a five star ranking in Motley Fool CAPS -- the highest possible -- except WuXi, which is trailing with a still respectable four star ranking. (Just so you know, from the time we launched CAPS to the beginning of July, five-star stocks as a group outperformed the market by 12 points, while four-stars did it by seven.)

Demand is here to stay
It doesn't look like the growth that CROs have experienced over the last few years is likely to go away any time soon, either. A recent report by Turner Investment Partners estimates that in the next few years CROs will be involved in half of all drugs at some point during development.

What's interesting though is that the CROs may be shifting who their source of revenue. Many smaller biotech companies are now using CROs' expertise to get early drug development done. That same report estimates that biotech now accounts for 30% of CROs revenue globally, up from 21% five years ago. It's a good sign that CROs have proven their worth when start-up companies are spending their precious cash to use their services.

And of course drug development happens in good economic times and bad, which makes CROs as much a recession-proof industry as the pharmaceutical companies they serve.

Drugmaker growth without risk
The best part of being a CRO is that, in general, they get paid whether a drug fails or succeeds. Sure their stock price isn't going to triple overnight, but you also won't see it slump on a failed clinical trial or Food and Drug Administration rejection.

With the FDA increasing the requirements for approval of drugs that treat some diseases, CROs running clinical trials could see their business grow faster than the drug industry as a whole. Additional and longer trials, especially the dreaded phase 4 ones, will likely be required to satisfy the FDA reviewers, and this benefits the companies handling the trials.

A winning industry
The CRO industry may not get a lot of press -- I'll bet the average Joe doesn't even realize that pharma has outsourcing. But CROs sure seem to keep their customers happy and coming back for more. As long as they can keep growing revenue and profit, investors should be happy too.

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Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. The Fool has a disclosure policy.


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