Hi-Tech Pharmacal: High Growth at a Value Price

by: Mike Havrilla

Shares of Home Diagnostics (HDIX) have surged by nearly 50% since I profiled the company in mid-December as a turnaround value play from the ETF Innovators Healthcare Cost Containment Index. A search for compelling values among these companies today led me to generic drug maker Hi-Tech Pharmacal (NASDAQ:HITK).

Shares of HITK are down by about 10% in the past five days on light volume and no news headlines, providing a nice chance to accumulate some shares. The Company reported record quarterly revenue for its second fiscal quarter and is expected to earn 41 cents per share for FY09 (which ends in April), which results in a P/E of about 11 based on the current price around $4.60 per share.

As illustrated in the accompanying one-month chart, HITK has lagged behind its peer group – including a gain of about 10% for Caraco Pharma (NYSEMKT:CPD) and over 20% for Mylan Labs (NASDAQ:MYL). Also, favorable trends for the generic drug industry include $70B in patent expirations through 2012, a push to increase generic substitution rates to 70% from 65%, and legislation expected this year to clear the way for generic versions of high-cost biotech drugs.

Despite the favorable growth outlook for generic drug makers such as HITK in the coming years, the stock trades at deep value parameters, trading at just two-thirds of its book value and trailing 12-month revenue. HITK holds $12.9M in cash with negligible long-term debt of $0.3M for an enterprise value (NYSE:EV) of $38M, yielding an EV to revenue ratio of 0.5X. Trailing 12-month revenue is $77M and the current market cap is $52M.

As with HDIX, HITK also believes its stock represents an excellent value, repurchasing a total of 94,000 shares of common stock during its last fiscal quarter ending in October for a total cost of $661,000 for an average price of about $7 per share. Investors today can buy shares of HITK at a steep discount of about 33% with shares hovering around the $4.60 level.

For the 2Q09, HITK posted a 44% increase from the year-ago period for generic drug product sales at $19.5M, boosted by $5.4M in sales of Dorzolamide with Timolol ophthalmic solution as the generic equivalent for Merck's (NYSE:MRK) Cosopt for the treatment of glaucoma. HITK also posted strong results for its consumer healthcare division, which also increased by 44% to $3.3M, thanks to newly launched brands which include Zostrix Neuropathy and Nasal Ease.

As expected with a multitude of new product launches during 2Q09, HITK experienced increases across the board from the year-ago period for the following:

  • cost of sales (up 28.4% to $13.1M, but down 12% as a percentage of sales to 52%)
  • research and product development (R&D) (up 20% to $1.8M)
  • selling, general, and administrative (SG&A) (up 31.6% to $7.5M)

The sharp increase in sales and higher margins for new products resulted in net income for the quarter of $1.1M, reversing a $1M loss in the year-ago period for diluted EPS of $0.09 versus a loss of ($0.08) last year.

The ongoing saga and recently extended $7.75 per share tender offer (until 1/30/09) for Taro Pharma (TAROF.PK) by India's largest generic drug maker by market cap, Sun Pharma (524715), offers a relative valuation comparison for a small-cap generic drug company. The $7.75 per share tender offer values Taro at about 0.9X sales or $283M; although the Company is currently trading almost $2 above the tender offer price at $9.55 per share.

HITK enjoys a stronger balance sheet than Taro, with the latter holding $66M in cash and net debt of $123M, which makes the actual purchase price for Sun Pharma even higher at an EV of about $400M and an EV to revenue ratio of 1.3X. On a relative valuation basis, HITK has about 2X upside from current levels to nine bucks, which would result in a similar EV to revenue ratio. Also, CPD would yield similar upside potential on a relative valuation basis and I own both of these stocks as my favorite value plays in the generic drug industry.