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Investing.com -- The outlook for Wilmington, Massachusetts-based contract research organization (CRO) Charles River Laboratories International Inc. (CRL) has been revised to stable from positive at S&P Global due to weak 2025 guidance. The company expects a revenue decline similar to 2024 levels and anticipates operating margin pressure. All ratings on CRL have been affirmed, including the ’BB+’ issuer credit rating.
The stable outlook is based on the belief that leverage will remain in the 2x-3x range, possibly exceeding 3x temporarily after an acquisition. CRL is expected to quickly deleverage post-acquisition due to its strong expected free cash flow and a history of maintaining leverage below 3x.
The outlook revision indicates that there is no longer an expectation for the business’ organic growth to recover in 2025. Business volatility is considered greater than anticipated. Charles River’s preliminary 2025 outlook suggests that its revenue and EBITDA will continue to be affected by constrained spending from global biopharma clients and demand trends from biotech clients similar to 2024.
The Discovery (NASDAQ:WBD) and Safety Assessment (DSA) segment, which accounts for about 60% of consolidated revenue, is experiencing lower study volume leading to mid- to high-single-digit revenue declines compared to the previous year. The company’s Contract Development and Manufacturing Organization (CDMO) business will also be limited by lower commercial revenue in 2025 due to changes in agreements with cell therapy clients.
Charles River, which focuses on pre-clinical trials, is highly dependent on the research and development (R&D) budgets of large pharmaceutical companies and exposed to fluctuating levels of venture capital investment in pharmaceutical and biotech start-ups. Early stage R&D projects are more sensitive to macroeconomic factors than the overall pharmaceutical industry and the broader health care industry. These projects are risky and can be put on hold or abandoned in an economic downturn.
The company is implementing cost-saving initiatives, including a 6% reduction in headcount and footprint optimization, expected to yield $200 million in annualized savings by 2026. This should help the company to maintain leverage below 3x. Charles River has prioritized debt repayment over the recent quarters, repaying over $300 million of revolver borrowings, bringing leverage down to 2.6x as of the third quarter 2024.
Charles River is viewed as a leader in the narrow pre-clinical trials space, with a leading market position, high margins, and solid long-term demand trends. The company has leading market positions across its three segments: discovery and safety assessment, research model services, and manufacturing solutions. The company has worked on more than 80% of the pharmaceutical products approved over the past five years.
Industry disruption by AI tools is viewed as a tail risk and is not expected to dramatically impact the company in the near term. In-vivo testing is required to predict the safety of pharmaceuticals before being tested in humans and it is not expected to be replaced by in-vitro testing or computer modeling within the next decade.
The outlook could be lowered if leverage is believed to remain well above 3x on a sustained basis. This could be the result of debt-funded acquisitions, or a scenario where demand for research models and contract research significantly and unexpectedly weaken for an extended period. On the other hand, an upgrade could be considered if CRL’s leverage trends toward the low-2x area and is expected to remain there.
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