Partnerships With Novartis And Lilly Will Strengthen Future Prospects

Key Takeaways

• Expansion in software and partnerships with pharmaceutical giants is expected to boost revenue and margins significantly.
  
• New AI applications and clinical trial successes will enhance product offerings and stabilize revenue streams.
  
• Shrinking gross margins, financial resource strain, and reliance on non-GAAP measures highlight profitability challenges amidst growth limitations and instability in the biotech sector.

Catalysts

Develops physics-based computational platform that enables discovery of novel molecules for drug development and materials applications.

• Schrödinger's momentum in expanding its software business through partnerships with major pharmaceutical companies like Novartis, along with a focus on computational technology and enterprise informatics platforms, is expected to drive revenue growth in 2025.
  
• The planned release of new AI and machine learning applications, including predictive toxicology technology, is set to enhance the company's product offerings, potentially increasing revenue and improving net margins by attracting larger client engagements.
  
• Growth in hosted software contracts, which are expected to account for a larger portion of the total revenue, should stabilize revenue streams throughout the year and reduce seasonal revenue fluctuations, impacting earnings positively.
  
• The achievement of key milestones in clinical trials for Schrödinger's proprietary programs is anticipated, which could enhance the value of their drug discovery pipeline and bolster future drug discovery revenue, positively influencing operating margins.
  
• Strengthening partnerships and collaborative revenue, particularly with high-profile companies such as Lilly and Otsuka, can add significant value and is expected to result in higher drug discovery revenue, which will improve earnings for the foreseeable future.

Schrödinger Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Schrödinger's revenue will grow by 24.1% annually over the next 3 years.
• Analysts are not forecasting that Schrödinger will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Schrödinger's profit margin will increase from -90.2% to the average US Healthcare Services industry of 12.2% in 3 years.
• If Schrödinger's profit margin were to converge on the industry average, you could expect earnings to reach $48.1 million (and earnings per share of $0.65) by about April 2028, up from $-187.1 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 58.4x on those 2028 earnings, up from -7.4x today. This future PE is greater than the current PE for the US Healthcare Services industry at 52.9x.
• Analysts expect the number of shares outstanding to grow by 0.49% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.24%, as per the Simply Wall St company report.

Schrödinger Future Earnings Per Share Growth

Risks

• The decrease in Schrodinger's gross margins, from 77.6% in Q4 2023 to 72.6% in Q4 2024, is primarily due to higher drug discovery expenses and costs associated with new projects, impacting overall profitability.
  
• A significant decline in cash and marketable securities balance from $469 million in 2023 to $367 million in 2024, driven by a net loss and increased operating expenses, could strain financial resources if this trend continues.
  
• Exposure to small biotech companies shows some vulnerability, as acquisitions of these companies contribute to customer churn, potentially jeopardizing stability and growth in the customer base and related revenue streams.
  
• There's an expectation of reduced growth from China and minimal contribution from emerging biotech companies, which may limit revenue diversification and growth avenues.
  
• The reliance on non-GAAP financial measures and related adjustments may obscure some operational weaknesses or irregularities in financial performance, leading to possible discrepancies in perceived versus actual earnings outcomes.

Valuation

• The analysts have a consensus price target of $30.8 for Schrödinger based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $39.0, and the most bearish reporting a price target of just $26.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $396.2 million, earnings will come to $48.1 million, and it would be trading on a PE ratio of 58.4x, assuming you use a discount rate of 7.2%.
• Given the current share price of $18.84, the analyst price target of $30.8 is 38.8% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.