Investors in Allergan (NYSE:AGN) saw solid returns in the second half of 2013 on the back of the continued growth of Botox and its eye-care products. Investors did see a significant pullback in the share price over the summer, on worries about increased generic competition for Restatis.
Yet shares recovered and analysts at Wells Fargo are optimistic that the company can fence off generic competition for Restatis for a bit longer than previously anticipated.
Despite these hopeful developments I remain cautious and stay on the sidelines on valuation concerns.
Wells Fargo Turns Optimistic
Analysts at Wells Fargo (NYSE:WFC) upgraded Allergan from "Perform" to "Outperform." Analyst Larry Biegelsen attaches a new $121-$122 price target to the shares. Despite the outperform rating, the price target represents nearly 13% upside potential from levels before the upgrade has been released.
The upgrade is based on the expectation that several new Restatis patents could be issued in the near term, which in its turn would delay generic competition. These new patients could delay generic competition well beyond the previous assumption of 2016.
Biegelsen bases his case on the review of three patent applications. The patents are expected to be issued in the coming months and should be quite robust, expected to hold up in litigation. As such three new patents are expected to be issued by the US patent office in the first quarter of 2014.
Therefore Biegelsen now sees 2016 and 2017 Restatis sales growth of 5% compared to a 50% decline as forecasted previously.
Solid Financial Position And Operating Results
Back in October, Allergan released its third quarter results. The company ended the quarter with $3.21 billion in cash, equivalents and short-term investments. With debt standing at merely $2.14 billion, the company has a great balance sheet with a lot of liquidity and a net cash position of nearly $1.1 billion.
Revenues for the first three quarters of last year came in at $4.61 billion, up a solid 10.6% on the year before. Reported GAAP earnings fell by 13.2% to $672.2 million. Non-GAAP earnings came in at $1.03 billion as they exclude losses from discontinued operations as well as amortization and restructuring charges. Note that these charges were sizable this year.
As such, Allergan is on track to report annual revenues of $6.15 billion and non-GAAP earnings of around $1.4 billion.
Trading around $111 per share, the market values Allergan at $33 billion. This values operating assets of the firm at $32 billion, roughly 5.2 times annual revenues and 22-23 times annual earnings.
Allergan pays a quarterly dividend of merely $0.05 per share, for a dividend yield of just 0.2%.
Strong Historical Share Price And Operational Performance
Long-term holders in Allergan have seen very strong returns. Shares traded in their thirties in 2004 to steadily rise to highs of $70 in 2007. Shares fell back towards $40 in 2009, but ever since have risen consistently towards highs of $116 earlier this year.
Shares fell to lows of $80 in June of this year following the FDA release. The guidance of the agency could make it easier to approve generic competition for the eye-care treatment Restatis. Shares have risen some 40% from those levels in just about half a year ever since.
Between 2009 and 2013, Allergan is expected to increase its annual revenues by a cumulative 37% to $6.15 billion. Earnings have seen significant growth as well. The difference between GAAP and non-GAAP earnings is due to the losses associated with the planned sale of the obesity intervention business.
Therefore the gap between both earnings metrics is expected to decline next year.
Implications For Investors
The future path of Restatis is crucial as well. The eye-care top-selling drug is expected to fetch $900-$920 million in annual revenues for 2013, making up 15% of total revenues.
Yet it is not just growing sales of Restatis, or the wider eye-care unit, which are boosting revenues. Botox sales were up by 12.5% as well in the third quarter, coming in at nearly $500 million for the quarter. Restatis sales were very strong as well, increasing 21% on an annual time frame to $239 million.
With revenues of the drug approaching annualized sales of a billion, expanding the effective lifetime without competition by a year or two is really nice. As such, a move as expected by Wells Fargo could easily add $2 billion in future revenues, combined with very fat profit margins given the low cost of sales of producing drugs. The sales additions alone of postponing generic competition on a billion dollar drug for two years, are equivalent to about $7 per share, and warrants the optimism from Wells Fargo if this scenario turns out to be reality.
To diversify away from blockbuster Botox and Restatis, the company focused on acquisitions to diversify. Yet the acquisition of MAP Pharmaceuticals earlier this year, to get a hold of Levadex, which is an experimental inhalation treatment, failed after the FDA rejected the treatment in April. Yet this has been countered by modest success of obtaining approval to market Botox for the treatment of "crow's feet lines.
Back in November of last year, I last took a look at Allergan's prospects following the $350 million acquisition of SkinMedica. Shares traded around $90 at the time. I concluded that shares were not appealing enough on the back of a low dividend yield and higher earnings multiple. This was despite the continued success of Botox and the strong balance sheet.
Today I reiterate that stance, I remain on the sidelines.