Syneos: Further Contraction Imminent In FY2023, Reiterate Hold

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Investment Summary

Syneos Health, Inc (NASDAQ:SYNH) posted its Q4 and FY22 numbers past week pinch upsides versus statement astatine nan apical and bottommost lines. In November past twelvemonth we released our past SYNH publication titled "Nothing's changed aft Q3 earnings" it was clear nan banal had surgery its pre-pandemic lows and value action consequent to its Q4 FY22 results has been flat, suggesting investors were expecting much from nan institution successful its last quarter. It landed astatine a book:bill ratio of ~0.4x astatine nan extremity of nan year, nevertheless nan commercialized conception recognized a 1.43x book:bill ratio aft nan section recorded its "second highest 4th of nett awards successful [SYNH's] history" to usage CEO Michelle Keefe's connection from the net call. Valuations look reasonably priced connected look value, however, aft a sluggish play of growth, nan patient guides to a 7% further pullback successful top-line maturation successful FY23, starring america to judge nan debased multiples whitethorn beryllium justified. Here I'll tally done nan awesome moving parts successful nan SYNH finance statement for nan use of investor reasoning. On nan culmination of these points raised successful this heavy dive, we reiterate SYNH banal arsenic a hold.

Fig. (1)

Data: SYNH Investor Presentation

SYNH Q4 analytics

Looking to nan reported numbers, nan institution clipped full gross of $1.36Bn, representing a 100bps YoY alteration connected a reported basis. Moving down nan P&L, quarterly adj. EBITDA besides contracted by 11.8% YoY to ~$209mm, a separator of 15.4% that compressed 190 ground points YoY. Looking astatine this successful greater detail, nan tighter separator chiefly resulted from little favourable gross mix, discussed below. Noteworthy, reimbursable expenses were higher than expected successful Q4, owed to nan ramping of 2 expense-heavy projects, 1 each successful nan successful nan objective and commercialized segments respectively. We'd statement that SYNH expects nan load of these projects to proceed into H2. It pulled this down to quarterly adj. EPS of $1.23, a 16.9% YoY decline. Contrasting this to nan its FY22 adj. earnings, it clipped a 580bps YoY summation to $4.72.

Turning to nan operational highlights, important takeaways for investors are arsenic follows:

1. Quarterly top-line maturation for nan objective solutions conception compressed by ~210bps YoY to $1.02Bn, and contributed ~75% to nan top-line. This reflects nan little favourable income mixed outlined above. The downsides were underscored by little nett awards and backlog conversion delays. Looking astatine nan full backlog, it totalled $10.13Bn astatine nan extremity of FY22, down from $11.4Bn, meaning it worked done ~$1.27Bn successful gross conversion from nan backlog complete nan year. Further, its objective solutions conception was partially supported by an 80bps tailwind from nan higher reimbursable expenses mentioned earlier. Expanding nan study to nan full-year, objective revenues came successful level to $4Bn, connected operating income of $689.5mm, aliases 12.8% of full sales..
2. Meanwhile, nan commercialized solutions conception clipped gross of $336.6mm successful Q4, a 250bps YoY. Growth was underlined by a beardown publication from nan company's Syneos One portfolio; however, nan conception besides realized a beardown 450bps tailwind from reimbursable expenditures. Backing retired this tailwind, nan commercialized franchise grew by conscionable ~50bps. Moreover, only 25% of nan top-line is attributed to this segment, and it booked $1.32Bn successful revenues for nan entirety of FY22. Moving down nan P&L, this came to commercialized solutions operating income of $159mm, a 2.9% operating margin.
3. The institution vanished nan twelvemonth pinch $427mm successful CFFO amounting to a $5.5mm summation successful rate aft a $2Bn indebtedness repayment, issuing $1.8Bn successful further notes payable, and $93.5mm successful CapEx. This pulled to $343mm successful FCF to nan firm. It besides repurchased $180mm successful banal passim nan year. Looking astatine its in installments summary, short-term obligations are covered >1.1x from liquid assets, liking costs is covered 8.5x from pre-tax net and equity holders person a bully declare successful nan superior structure, pinch a indebtedness ratio of conscionable 21%. Notably, however, is that ~61% of nan company's plus guidelines is comprised of goodwill, meaning it has a antagonistic tangible book worth of $2Bn, aliases antagonistic $20.24 TBV per share. Further, an further 21% of nan firm's assets are made from receivables, and conscionable 5% arsenic tangible assets. Hence, the ROA of 3.25% is moreover little charismatic arsenic a chunk of this is simply a return connected goodwill, nan premium paid supra adjacent worth for nan costs of its acquisitions.

Fig. (2)

Data: Author, adapted from SYNH FY22 10-K

Moreover, moreover though SYNH is profitable, taking a longer-term view, we extrapolate further captious insights from its capacity complete nan 5-years to date. I'd punctual readers that a patient creates early worth for its shareholders pinch a multi-pronged strategy involving maturation and return connected capital. We tin instantly measure nan firm's occurrence of this by examining 1) precocious return connected invested superior that exceeds nan costs of capital; 2) maturation successful post-tax earnings; 3) what percent of net it reinvests for early growth; and 4) what percent of net is leftover arsenic residual rate flows distributable to equity holders, aft nan reinvestment for early growth. Key to nan full continuum, is that nan ROIC exceeds nan costs of superior [otherwise known arsenic an economical profit]. If it doesn't, past maturation destroys value, per Mauboussin (2020). This is an basal constituent to grasp because it thief america necktie together nan conception of valuation from an investors perspective, helping supply a amended knowing of nan rate flows to beryllium received into nan future. Alas, not each maturation is created equally, and maturation comes astatine a costs to shareholders – truthful we request to understand what this costs is, and if early maturation is going to really accretive to worth for SYNH. Doing so, we tin make elaborate inferences astir its early value, and what benignant of maturation floor plan we tin expect to spot complete a semipermanent horizon. Looking to Figure 3, we spot that SYNH has been profitable complete nan 5-years to date, pinch yearly ROIC lifting from 3.6% to 8.4%. It's grown NOPAT by $323mm by investing an further $595mm successful superior for early growth, a 54% cumulative 5-year return connected investment. With nan $2Bn successful cumulative NOPAT generated, it has reinvested ~30% of this to execute that return. Subsequently, nan maturation complaint is recorded astatine 15.8% complete this time. These are reasonable maturation percentages.

Fig. (3)

Data: Author, utilizing information from SYNH SEC Filings

There's much to it than this, however. SYNH's yearly ROIC hasn't beaten nan yearly costs of superior from FY18–22', arsenic seen successful Figure and Figure 5. Consequently, from an investors perspective, nan company's maturation complaint hasn't been accretive to worth [as outlined earlier erstwhile nan ROIC<hurdle rate]. Why is this of value to nan finance statement for SYNH? To quote Mauboussin (2020) directly,

"the basal rule is that maturation only adds worth erstwhile nan institution earns a return connected its finance that is supra its costs of capital. The higher nan return, nan much delicate nan business is to growth. Growth is of nary economical value if a company’s returns are balanced to nan firm’s costs of capital. As a consequence, companies should attraction not connected maturation per se but connected value-creating growth"

Subsequently, this creates a valuable instrumentality for america to measure SYNH by successful position of valuation and what it needs to do looking up successful bid to thrust value-creating growth for shareholders. We request to spot nan institution generating a higher return connected its investments for one, and spot it transcend nan WACC hurdle successful bid to spot nan banal waste and acquisition a higher multiple, by estimation. This is quintessential, and, if it can't put astatine return that exceeds its WACC hurdle, past we estimate that investors will proceed to shun nan banal for much selective opportunities that do connection this benignant of profile. We will benchmark SYNH against these numbers moving into nan future.

Fig. (4)

Data: Author, utilizing information from SYNH SEC Filings

Fig. (5)

Data: Author, utilizing information from SYNH SEC Filings

Forward guidance points to further contraction

Moving connected to nan 2023 guidance, SYNH expects different pullback successful a turnover to a scope of $4.98Bn–$5.18Bn, calling for a diminution of 4–7.8%. It bakes successful a FX headwind of $10mm connected this. Curiously, it besides incorporates a projected headwind of 100bps from reimbursable expenses. It besides projects adj. EBITDA to $725mm astatine nan precocious extremity of range, calling for a separator of 14% – different 100bps FY22. It hopes to propulsion this down to non-GAAP EPS betwixt $3.26–$3.53, a c.31% alteration astatine nan precocious bound. Looking to nan near-term, nan institution expects Q1 gross of ~$1.31Bn connected adj. EBITDA of $148mm astatine nan precocious end. Again, looking astatine Q1 FY11, this calls for a gross diminution of 2–5.7% to 2% and adj. EBITDA pullback of 15–21.7%. The wind-back successful net supports further findings connected nan company's profitability and economical profit discussed above. The problem being, that for investors, this intends a little declare connected free rate flows and imaginable restrictions to valuation upside, again supportive of a neutral view.

Valuation and conclusion

On look worth nan banal trading astatine a discount to peers astatine 7.8x trailing non-GAAP net is attractive, nevertheless we'd constituent retired that this is besides a 57% discount to SYNH's 5-year average. Importantly, SYNH isn't nan aforesaid institution it was 5-years ago, and we person discussed earlier nan impacts of its ROIC not beating nan hurdle rate, and really this has perchance eroded shareholder value. Alas, nan 58% discount to nan manufacture P/E whitethorn beryllium justified. Further, it trades astatine 1.08x book value, but nan bulk of its book worth of equity is comprised of goodwill, arsenic mentioned. Looking astatine guardant multiples, we deliberation nan 7.8x aggregate is justified, arsenic mentioned, and assigning this to nan firm's telephone for $3.53 successful EPS derives a value target of $27. This is supportive of a clasp standing connected SYNH.

In short, SYNH has faced headwinds to creating worth to shareholders, based connected nan blend of level income growth, ROIC that hasn't beaten nan costs of capital, and contracted guardant guidance for FY23. Each of these factors are supportive of a neutral viewpoint. In that vein, we complaint nan banal a hold, and look guardant to seeing SYNH make a higher complaint of return connected its investments, and thrust free rate flows higher into nan future. The clasp standing is besides supported by nan quant standing system, adding further weight to this call.

Fig. (6)

Data: Seeking Alpha, SYNH, see: "ratings"

Buy broadside equity strategist conducting a blend of fundamental, technical, semipermanent study crossed nan wide healthcare spectrum successful developed markets. Helping you position your portfolios for nan early is my apical priority. Shoot maine a connection to talk waste and acquisition ides aliases talk portfolio construction. Disclaimer:The opinions expressed successful each articles do not represent arsenic finance advice. Please retrieve to behaviour your ain owed diligence.