Biovail: Upside Potential, High Dividend Yield

Quarterly Result Summary:

• Revenue fell to $181.5 million from $203.9 million a year earlier, hurt by declining sales of key treatments.
• Considers nominating new members to the board and change some corporate governance provisions.
• 76 cents a share, during the quarter, compared with a loss of $32 million, or 20 cents a share a year earlier
• Excluding charges, earned 34 cents a share, down from $72.5 million, or 45 cents a share
  

Overall, Biovail (BVF) was showing weak results due to competition from generic drugs. For example, sales of its Wellbutrin antidepressant drug fell 66%. Revenue for Ultram, its chronic pain treatment, fell almost 25%.

Company Highlights (or is it Company Identity Crisis?)

• Plans to spend $600 million through to 2012 on research and development of new treatments for central nervous system (CNS) disorders.
• Corporate governance: Is this gossip in the corporate office? Melnyk is BVF's former owner. Recently he is pushing on adding new board members. This time, the company is correctly open to this idea. It is a good sign and direction for a positive change for BVF shareholders.
  

Vital Valuation Statistics:

1. Annual Sales: 842.8M (2007)
2. Assets: 707.02M, Liabilities: 367.58M (No long-term debt)
3. Earnings stability: 2007: $1.22 2006: $1.35 2005: $1.61 - Average = $1.39
4. Dividend: $1.50/sh = 13.7% Yield
5. Earnings Growth - N/A
6. P/E - 11.29 (on paper this suggests value, since its P/E is under 15)
7. Book value = $7.33 (Current price @ 10.58 less than a rule of thumb value of 1.5x$7.33 = $11.00)

Technical Analysis

See chart here. BVF broke its downtrend in December 2008. It is currently finding support at $10.50. This support may be broken in the short term. As a result, BVF should be accumulated on weakness, on the $7.50 to $8.50 level if that level is reached.

Historical Valuation Analysis:

Unstable earnings and non-meaningful earnings growth would explain the low valuation of BVF. As such, BVF does not have the safety for the most conservative of investors. Low valuation will be a big factor for investors who want "in" on a company that produces generic drugs. Fundamentally, lack of debt and cash flow characteristics will be the characteristics that make this investment appealing when compared against its risk profile.

The earnings power (also called earnings yield) = 8.86%

Compare this to a 2 year municipal bond @ 1.3%

Compare this to a 10 year municipal bond @ 3.29%

Compare this to a 30 year municipal bond @ 4.88%

The margin of safety for BVF is 8.86% + 13.7% - bond yield = 23% - 5% = 18%!

The dividend appears unsustainable. Even with a dividend cut, the base margin of safety is still between 3% and 9%.

Note however, that this calculation of safety depends on two things: a low interest rate environment. The 18% safety is required because of the increasing competition the company continues to face. Investors need to be sure that the company buys companies that diversify its product base, increases cash flow, and improves margins.

In simple terms, if BVF is able to produce or acquire drugs that are new to market and enjoy patent protection and little competition, investors win. Serious investors must review the products under development at BVF. At this time, I believe the margin of safety is adequate enough for investors to wait for this event to happen.

Conclusion:

Buy BVF. Its yield is unusually high. Even if its dividend gets cut (which the market has already priced into the stock, although some of this discount was removed during the 50% rally over the last few months), BVF is trading at a very low valuation. It has $226M cash. This is $1.428 per share.

BVF should be accumulated on weakness, on the $7.50 to $8.50 level if that level is reached. A break below $7.50 negates my short-term bullish position as outlined. Still, this is a long term stock to hold.

Since the outstanding bullish variable is the need for BVF to have new products to improve profit and margins, I am not assigning a price target for Biovail.

Disclosure. I hold a long position on Biovail. Here is a link to my portfolio on kaChing.