Actavis Primed To Outperform Through 2014

| About: Allergan plc (AGN)

Actavis plc (ACT) ends an eventful 2013 having almost doubled in price from $85 to $166 at the time of writing. The main event of the year was the $8.5 billion buyout of Irish drug maker Warner Chilcott effectively creating the third largest specialty pharmaceutical firm in the United States. With the dust starting to settle on the deal the question for investors is whether Actavis can replicate the strong gains in 2014.

Headed by CEO and Chairman Paul Bisaro, Actavis is a global pharmaceutical company that develops, manufactures and distributes generic, branded and over the counter products. They're responsible for over 750 products in more than 60 countries. The company counts over 30 manufacturing and distribution outlets worldwide and 20 research & development centers. A leader in women's health, Actavis seeks to develop and manufacture pharmaceuticals of the highest quality.


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Source: Yahoo Finance

Earnings Acceleration Excites Investors

The exceptional rise in stock price during 2013 was underpinned by three quarters of earnings per share acceleration culminating in a strong third quarter showing of 55% on a sales increase of 57& year on year. Analysts estimate a fourth quarter increase in EPS to 89%.

Longer term numbers have also impressed. Annual EPS has grown four consecutive years with the three year rate hovering around a 35% increase. Margins remain solid at 19.6% with a well managed return on equity of 20.8%. Gross margins had increased to 51.5% from 47.2% the prior year with the Ortho-McNeil-Janssen contract for the generic version of Concerta being the key driver.

Warner Chilcott Set To Deliver

Investors remain buoyed by the Warner Chilcott deal as the company has dramatically reduced its reliance on generic drugs which were responsible for 75% of revenue the preceding year. Just as appealing is the expected increase in revenue from specialty brands which could contribute up to 25% of company wide sales in comparison to around 7% pre-Warner Chilcott.

CEO Bisaro believes the company is well on track to complete the aggressive integration of Warner Chilcott which is expected to yield $400 million in tax savings and an additional $50 million in interest savings after the refinancing of long term notes.

New Product Expected To Feed Into The Bottom Line

During the third quarter Actavis released a generic version of Lidoderm which is a pain relief patch commonly used after a bout of shingles. The branded version sold by Endo Health Solutions (NASDAQ:ENDP) provides annual revenues of around $1.2 billion. Actavis will be the only company with a generic solution so this is expected to boost generic drug sales substantially to a possible $300 million clip.

Generic Lidoderm is an example of company capabilities and it's the CEO's intention to use free cash flow to reinvest into significant growth opportunities wherever he may find them. The business is strongly focused on women's health but that won't stop the business seeking out high yield propositions such as dermatological functions or new markets such as Southeast Asia or Russia. This includes further acquisitions if necessary.

Competition Remains Stiff

Perrigo Company Plc (NASDAQ:PRGO) is another generic drug maker that is seeking to keep pace with Actavis as its own acquisition strategy maintains an aggressive pace. The recently completed buyout of Elan plc (NYSE:ELN) is expected to result in cost and tax savings of up to $150 million and an additional 10 cents per share for Perrigo's non-GAAP EPS in 2014.

The company has maintained its dealmaking appetite at a lower debt/equity ratio (83%) than Actavis. Whilst this latest deal promises to augment Perrigo's attractiveness to investors, there was a 4% increase in fund ownership during the last quarter, its recent performance has been lagging. The 3 year sales growth rate is sluggish at 14% compared to Actavis' 32% and last quarter's 20% increase in EPS was dwarfed by Actavis' 55%.

High Debt Ratio Presents Higher Risks

Actavis is currently running a Debt/Equity ratio of 163% which is a red flag for prudent investors. However, the level is unsurprising given the aggressive nature of Actavis' acquisition plans. As long as management maintains hitherto high levels of due diligence to ensure that purchases are immediately accretive, then the debt can be easily serviced and reduced by the company's cash generating capabilities.

Fund Managers Continue To Support New Price Highs

Further support to the increasing stock price can be found from large trend followers and fund managers. Trend followers like to see new price highs to confirm strength and underlying support from institutional investors. Third quarter statistics show that there was a 3% increase in fund ownership and the second quarter in a row that big investors have increased holdings. Management retains 1.3% ownership of stock which is within the parameters expected of a company of this size although a dip below 1% would be a negative signal for investors.


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Source: Yahoo Finance

Conclusion

Actavis is primed for another year of growth after the successful integration of Warner Chilcott. The associated savings and earnings accretion should underpin continued investor appetite. With the bull market in stocks appearing to be confirmed again after the strong positive reaction to the Fed's confirmation they'll be tapering the bond buying program, the downside risk to price gains is reduced. However, concerns over leverage persist and it's incumbent upon management to ensure that the anticipated cash flow from acquisitions is invested well. Bottom line growth needs to be organic rather than dependent upon availability of credit for future purchases. With this risk contained Actavis promises to continue to exceed investor expectations throughout 2014.

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.