Neogen Corporation, a leader in food and animal safety, recently released its Q3 2024 earnings transcript, detailing the ongoing integration of the former 3M Food Safety division. While the transcript focused heavily on shipping inefficiencies, a deeper dive into the numbers reveals a potential hidden gem: the strategic shift in Neogen's genomics business.

Neogen's move away from small production animals in its genomics segment, while seemingly a simple cost-cutting measure, could actually be a brilliant maneuver to enhance profitability and position the company for long-term success. This strategic shift, overshadowed by the immediate concerns of shipping woes, might be the key to unlocking Neogen's potential for high-single-digit growth and attractive EBITDA margins.

The genomics segment, primarily focusing on animal DNA testing for breeding and disease prediction, has historically been a strong performer for Neogen. However, the recent transcript highlights a deliberate shift in focus towards larger, more profitable production animals and companion animals, a move not widely discussed by analysts.

Why is this shift so significant?

The genomics market for small production animals, primarily poultry, has become increasingly commoditized, characterized by intense price pressure and shrinking margins. Poultry producers, facing their own economic challenges, have been pushing for lower testing costs, squeezing profitability for service providers like Neogen.

Neogen's decision to step away from this price war demonstrates a keen understanding of market dynamics. By focusing on larger animals, which represent a higher value proposition for producers, Neogen can command premium pricing and maintain healthy margins. This move is also aligned with the growing companion animal market, driven by rising pet ownership and increasing demand for genetic testing services.

The Q2 2024 earnings transcript indicated an estimated $3 million to $4 million revenue impact from customer losses in the small animal genomics market. While seemingly a loss, it could be a strategic sacrifice for a greater long-term gain. The shift allows Neogen to optimize resource allocation, focusing on segments with greater potential for sustained profitability.

Hypothesis: Margin Improvement through Strategic Shift

Consider this hypothesis: If Neogen can maintain its core genomics revenue in other segments while shedding the low-margin small animal business, the overall impact on revenue could be negligible. Simultaneously, by focusing on higher-margin segments, Neogen could see a significant boost in its EBITDA margin for the genomics business, potentially driving it closer to the company's overall target of 30%.

This hypothesis is supported by the Q3 2024 transcript's statement that 'Genomics, we're seeing the business stabilize as we shift our focus towards the large animal end of the market. Although, still down on a year-over-year basis, we did see core revenue trend positively for the second quarter.' This indicates that the shift is already contributing to a stabilization of the genomics business.

"Furthermore, John Adent, Neogen's CEO, expressed confidence in the company's long-term growth potential, stating, 'Absolutely, it can, because again, when we talked about those numbers [high-single-digit growth and 30% EBITDA margin], that was always our jumping off point from when the businesses are combined.' This reinforces the notion that the strategic shift in genomics is a key part of achieving these targets."

Impact of Shipping Inefficiencies

While resolving the shipping inefficiencies remains a top priority for Neogen, investors should not overlook the strategic brilliance of this genomics shift. As the integration progresses and the end market environment improves, Neogen's focus on high-value segments in its genomics business could very well be the hidden driver of the company's future success.

Visualizing Shipment Efficiency Improvement

While Q3 2024 saw flat order backlog, Neogen highlighted improvement in shipment efficiency. The following chart visualizes this based on commentary from Dave Naemura (CFO) and John Adent (CEO).

"Fun Fact: Did you know that Neogen's expertise in food safety extends to outer space? The company provided test kits used by NASA astronauts to monitor the safety of food grown on the International Space Station."