Margins And Revenue Challenges Will Slow Progress Yet Kindle Potential

Key Takeaways

• Reliance on large pharma clients and high R&D outlays limit revenue growth and keep earnings negative despite new product initiatives and expanding collaborations.
  
• Intensifying competition, slow adoption by new customers, and regulatory uncertainties challenge sustained pricing power and margin improvement.
  
• Heavy reliance on existing large customers, margin pressures, sector challenges, dependence on milestone payments, and cost-cutting measures all threaten stable future growth and profitability.

Catalysts

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

• Although Schrödinger is positioned to benefit from long-term increases in AI-driven drug discovery and rising global R&D spending, ongoing reliance on existing large pharma clients limits the pace at which these trends translate to top-line revenue growth, with minimal contribution from new customers due to a persistently challenging biotech funding environment.
  
• While the expansion and refinement of Schrödinger's software suite and the release of new modules like predictive toxicology represent important long-term growth levers, significant investments in these initiatives continue to depress software gross margins, and the timeline for meaningful financial contribution remains uncertain given the early-stage nature and slow feedback from initial users.
  
• Despite the potential for computational tools to lower costs and accelerate drug development industry-wide, competitive pressures are intensifying as alternative AI and open-source solutions mature, raising the risk that Schrödinger's pricing power and recurring revenue growth could erode over the long term.
  
• Although international expansion and deepening collaborations could diversify future revenue streams, regulatory uncertainties, including potential tightening of compliance requirements and protectionist trade measures, may restrict the company's global addressable market and add operational complexity, ultimately constraining margin improvement.
  
• While milestone payments and royalties from the growing pipeline of partnered and proprietary drug programs offer the possibility of significant future earnings, ongoing delays in clinical trial progression, dependence on partnership structures, and high R&D outlays may lead to persistently negative earnings and limited near-term offset to current operating losses.

Schrödinger Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Schrödinger compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Schrödinger's revenue will grow by 14.7% annually over the next 3 years.
• The bearish 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 -76.2% to the average US Healthcare Services industry of 8.8% in 3 years.
• If Schrödinger's profit margin were to converge on the industry average, you could expect earnings to reach $31.4 million (and earnings per share of $0.42) by about September 2028, up from $-181.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 57.1x on those 2028 earnings, up from -7.8x today. This future PE is greater than the current PE for the US Healthcare Services industry at 54.6x.
• Analysts expect the number of shares outstanding to grow by 1.03% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.01%, as per the Simply Wall St company report.

Schrödinger Future Earnings Per Share Growth

Risks

• Schrödinger's software revenue growth is heavily reliant on renewals and scale-ups from its existing large customers rather than new customer acquisition, making the company vulnerable to revenue concentration risk and lower future revenue growth if major customers reduce or fail to renew.
  
• The company is experiencing ongoing margin pressure, with software gross margins declining from 80% to 68% year over year, due in part to the costs associated with the predictive toxicology initiative and a changing revenue mix, which could limit long-term net margin expansion.
  
• Persistent challenges in the biotech segment and broader macroeconomic uncertainty, including regulatory and drug pricing pressures, may constrain budgets for Schrödinger's products and services among key customer cohorts, putting future revenue growth at risk.
  
• The company's drug discovery revenue is currently buoyed by large upfront and milestone payments from collaboration partners such as Novartis, but continued dependence on achieving milestones and successfully commercializing proprietary drug candidates exposes future earnings to significant volatility and potential downside if development programs experience setbacks.
  
• Sustained high R&D expenditure requirements and recent company-wide expense reduction initiatives, including headcount reductions, signal ongoing cost pressures and highlight the risk that Schrödinger may need to further constrain investment in innovation to preserve cash, which could negatively impact the company's ability to maintain its competitive edge and long-term earnings trajectory.

Valuation

• The assumed bearish price target for Schrödinger is $19.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Schrödinger's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $33.0, and the most bearish reporting a price target of just $19.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $358.7 million, earnings will come to $31.4 million, and it would be trading on a PE ratio of 57.1x, assuming you use a discount rate of 8.0%.
• Given the current share price of $19.29, the bearish analyst price target of $19.0 is 1.5% lower. The relatively low difference between the current share price and the analyst bearish price target indicates that they believe on average, the company is fairly priced.
• 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.