Market Has Overreacted To The Actavis Acquisition News

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 |  About: Allergan plc (AGN)
by: Core Equity Research

A substantial increase in activity was witnessed in the shares of Actavis (ACT) as it was reported that the company is to buy Warner Chilcott in a $5 billion stock deal. The company has pursued this move in order to expand its product portfolio. Management has also indicated that this move will strategically address the taxes and improve future profits of the company. By acquiring Warner Chilcott, the company has brought the gastroenterology and dermatology businesses under its roof. With this increase in activity, the stock price of the company has been subject to some volatility. This situation has introduced a number of factors, both fundamental and technical, which need to be addressed in order to aptly evaluate the company as a prospective investment.

Actavis is a global specialty pharmaceutical company that develops and sells generic and over-the-counter products. The company's business is further divided into a few segments, which include Pharma, Specialty Brands, and Distribution. The company's competitors include Teva Pharmaceutical Industries (NYSE:TEVA) and Mylan (NASDAQ:MYL).

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Source: Bloomberg.

The above chart shows the stock price of Actavis since the beginning of FY 2013. A steep upward movement is evident over the recent periods as company's acquisition news began to be reported in the news.

Financial Performance & Fundamental Factors

The company's financial performance has been particularly weak in terms of profitability. The income statement summary provides a clear perspective regarding the low margins and decreased efficiencies of the company, despite commendable top-line growth.

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Data Source: Morningstar.

The above chart shows the income statement summary of the company in the past five years. Actavis has reported a substantial top-line growth over the last five years, but the margins have consistently plunged throughout this period resulting in lesser earnings. In the trailing 12 months figures, we see that the company has started reporting losses. This indicates that the upswing in the company's stock price is not being backed by its financial performance.

The underperformance of the company's businesses is not limited to the income statement. Some key performance and stability indicators suggest that the company's position is weakening across multiple standards.

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Data Source: Morningstar.

The above chart shows liquidity and credit ratios, which are prime indicators for the company's financial position. The liquidity ratios show a substantial decline, which directs toward possible liquidity problems in the near future as the company holds more current liabilities as compared to liquid assets. This decline can prove to be detrimental for the company. Similarly, the financial leverage and debt to equity ratio suggest that the company's financial health is weak as the company capital structure is inclined toward a high gearing degree.

Technical Factors

Along with the unimpressive financial performance of the company, a number of technical indicators are also suggesting that the company is not a good investment to hold at the current stock price. At the same time, the proportion of short positions in the company's float are limited to 1.42%, suggesting that the sentiment surrounding the company's stock price is inclined toward an appreciation.

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Source: YCharts.

The above chart shows the stock price of the company and standard Bollinger Bands since the beginning of FY 2013. The chart clearly reflects on the recent upward surge, but also indicates the overbought position of traders and investors in this stock. Also, the spread of the two bands represents volatility in the stock price, indicating the level of risk associated with the stock. We can clearly see that the spread has widened in recent periods and the volatility has substantially increased.

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Source: YCharts.

The above chart shows the trade volume, relative strength index (RSI), and moving average convergence divergence (MACD) line since the beginning of FY 2013. The volume chart indicates an improvement in market's interest toward the stock as the trade volumes have shown a substantial increase in the recent periods. The RSI figure of 83.05 is also unmatched across the reference period. This indicates a sizable overbuying trend in the market and suggests that the investors and traders should reverse their positions as the market will look for a correction.

The MACD is the most convincing of these technical indicators. The fact that the MACD has moved substantially above the signal line suggests the overbought positions in the market. Furthermore, the high level of divergence indicated in recent periods from previous trends suggests that the market has overreacted to the underlying news regarding the company, and it's time to re-evaluate the stock. In this case, these indicators are pointing toward a downward revision of the stock price and suggesting a short position for investors and traders.

Conclusion

Considering the aforementioned factors, I propose a sell recommendation of the stock as indicators across multiple aspects are suggesting that the market has overreacted to the acquisition news, and the underlying financial performance of the company does not support this new stock price. The risk associated with the stock price has also increased, which should make the risk-averse investors realize their profits and exit their positions. More risk-taking traders should consider option strategies to benefit from the correction of the company's stock price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.