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Morningstar | Narrow-Moat IQVIA Reports Robust Top-Line Growth in 1Q; Shares Remain Overvalued

Contract research organization IQVIA started the year well, with $2.7 billion in revenue slightly surpassing our expectations and representing 7.2% growth in constant currency (4.7% reported). Despite currency headwinds and the termination of a major trial, management maintained full-year guidance and affirmed that the operating environment for clinical development services remains strong. After adjusting our near-term revenue outlook for the technology and analytics segment, which performed ahead of our expectations, we anticipate a low- to mid-single-digit increase to our fair value estimate. The strong results in both the technology and research and development segments are supported by the intangible assets and switching costs that underpin the company's narrow moat.

The technology and analytics segment posted over $1 billion in revenue, up nearly 13% in constant currency (9% reported). On the call, management pointed out that about one third of the technology segment is the legacy IMS data business, which does not grow, leaving real-world evidence and IQVIA's customer relationship management platform, named OCE, to drive the segment with double-digit growth. Sales from these products and services have accelerated quicker than we expected, resulting in 7% organic growth in the technology segment this quarter compared with historical levels of 4% to 5%.

The research and development segment contributed $1.4 billion in revenue this quarter, up 5.3% in constant currency (3.7% reported). Backlog grew to $17.2 billion, after adjusting by $390 million for the termination of a major late-stage Alzheimer's trial. Even without adjusting for the canceled trial, quarterly backlog growth seems to be slowing down slightly on a sequential basis. With that said, adjusted backlog growth on a trailing 12-month basis of 13.4% remains healthy. Further, the company anticipates that $4.9 billion will be converted into revenue in the next 12 months.

Operating expenses were in line with our expectations, and we believe the company is on track to improve operating margin by about 100 basis points in 2019. Free cash flow was weaker than expected this quarter at negative $28 million, due to annual incentive payments to employees, higher capital expenditures, and a headwind from the timing of reimbursements associated with the company's loyalty program. We increased our near-term capital expenditure expectations as IQVIA continues to invest in its technology offerings and expect free cash flow to normalize in the remainder of the year. IQVIA remains highly leveraged, with over $11 billion in debt and a net leverage ratio of 4.6 times trailing adjusted EBITDA. We expect healthy cash generation from both the clinical research and the technology segments and do not have concerns about the company meeting its debt obligations.