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Morningstar | Raising Icon's FVE to $123 Due to Better Near-Term Outlook Following Strong Revenue Growth in 1Q. See Updated Analyst Note from 02 May 2019

Narrow-moat Icon outperformed our expectations in the first quarter, with revenue of $675 million up 11% on a constant currency basis (9% reported). The recent acquisition of MolecularMD, a specialty lab that focuses on diagnostics and biomarkers for oncology trials, helped boost revenue, but even excluding MolecularMD's contribution, revenue growth was over 10% (constant currency). We've raised our top-line expectations for the full year to about $2.8 billion, which is near the midpoint of management's raised guidance and represents 8% reported growth from 2018. We've also increased our revenue expectations for the near term as we expect MolecularMD will help Icon achieve high-single-digit annual growth in the next few years. With this change, we are raising our fair value estimate by a mid-single-digit percent to $123 per share. We're maintaining our narrow moat rating for Icon and continue to believe that it benefits from strong intangibles and high switching costs due to the complex, mission-critical nature of clinical trial work.

Icon's gross margin of 29.5% decreased 110 basis points from last year after several quarters of steady decline. We're not overly concerned by the lift in costs from upward pressure on wages because the company does a good job of managing its costs. In the first quarter, Icon trimmed its selling, general, and administrative costs, more than offsetting the pressure on gross margin. Ultimately, this resulted in operating margin improvement of 30 basis points from last year and 10 basis points from last quarter. We expect modest operating margin improvement throughout 2019.

Backlog growth was in line with expectations, up over 10% from last year, similar to recent quarters. Closing backlog was $7.9 billion, and this includes zero-margin reimbursed expenses, which we estimate makes up about 30% of backlog. CEO Steven Cutler expressed that the contract research organization (CRO) operating environment remains robust, with the larger CROs taking share from smaller players.

Further, Cutler hinted that there could be news of a potential acquisition in the coming months. We expect the company to continue with its strategy of small, tuck-in acquisitions. Its recent acquisitions have been related to oncology diagnostics (MolecularMD) and clinical development (Mapi Group). We would not be surprised to see further foray into biomarker diagnostics, given the growing importance of biomarkers in forming patient pools for trials. Alternatively, we could see an acquisition to expand capacity or better predictive analytics for clinical trial design.