Fortrea: Despite Headwinds, Shares Undervalued for Long-Term Investors; $35.50 Fair Value Estimate

We have launched coverage of Fortrea FTRE, a global contract research organization, or CRO, which was created after LabCorp spun off its clinical development business in June 2023. LabCorp had entered the CRO space through its acquisition of Covance in 2015 for $6.1 billion. We assign Fortrea a fair value estimate of $35.50 per share, and it’s currently trading in 4-star territory about 19% below our fair value estimate. We believe Fortrea has a narrow economic moat based on its significant late-stage clinical trial exposure, regulatory expertise, and strong client relationships, which are supported by intangible assets and high switching costs.

We anticipate Fortrea will experience some headwinds associated with operating as a newly stand-alone company post-spinoff from LabCorp, which will weigh on revenue and margins in the near term. Our High Uncertainty Rating reflects these heightened risks. However, we have a positive long-term outlook thanks to steadily increasing clinical trial outsourcing demand across the CRO industry.

We forecast 2023 revenue will reach about $3.07 billion, representing a decline of nearly 1% from the prior year. LabCorp announced the spinoff in July 2022 and since then, some customers became more hesitant to book new business due to uncertainty surrounding the spinoff, including who would lead Fortrea and how the spinoff would transpire. Management refers to this disruption as their “spin year” and is hopeful it is behind them, but we are skeptical that Fortrea will be able to quickly recover from the negative impact of this “spin year.” Some of Fortrea’s customers deferred their work while others took their new business to competitors, and we anticipate Fortrea’s revenue will grow in the low single digits over the next couple of years as it recoups the revenue from these lost opportunities.