Taro: The Best Opportunity In Pharma

May.29.14 | About: Taro Pharmaceutical (TARO)

Summary

Taro has net cash, strong cash flow, cheap valuation, and an aligned management team.

It enjoys better value than Valeant.

The company is a potential buyout target.

Taro Pharma (NYSE:TARO) received a lot of attention in 2012, when Sun Pharma was making repeated buyout offers and a number of people wrote articles encouraging shareholders to reject the offers.

Fast-forward to today, despite shares appreciating over 100%, the shares still represent tremendous value, and it seems very few investors are paying attention to the consistent cash flow and cheap price.

This week, Taro reported earnings - results were strong across the board, with revenue up 13% and EPS up 90%. Following such strong results, I expected the shares would have a strong showing, but when they only traded up 1% on the news, I thought I might be missing something, so I pulled together a comparison of Taro to other pharma options.

First, I wanted to look at Taro vs. other large pharma companies. The table below looks at Pfizer (NYSE:PFE), Merck (NYSE:MRK), Johnson & Johnson (NYSE:JNJ), and Novartis (NYSE:NVS) as four representative companies.

Market Cap (($B)) Revenue Growth EPS Growth Net Cash on BS Net Cash as % of Mkt Cap P/E
TARO 4.8 13% 91% 0.6 13% 11.7
PFE 189 -9% -5% -3.1 -2% 20.3
MRK 166 -4% 10% -7.6 -5% 24.4
JNJ 285 3% 35% 12.1 4% 15.1
NVS 220 1% 25% -13.5 -6% 18.5
Large Pharma Average 215 0% 16% -2% 19.6
Click to enlarge

Taro is growing its top and bottom line faster than large cap pharma options, it has net cash on the balance sheet (and a significant amount at 13% of market cap) vs. generally net debt for large pharma, and trades at a significant discount on a Price/Earnings metric. If Taro were to trade in line with the large pharma average, shares would go for ~$180, 68% higher than today's price.

But maybe large pharma isn't a reasonable comparison. Taro does a number of OTC/generic medication, maybe we should look at it relative to other OTC/generic companies. In the following table, we look at Taro vs. Teva (NASDAQ:TEVA) and Mylan (NASDAQ:MYL).

Market Cap Revenue Growth EPS Growth Net Cash on BS Net Cash as % of Mkt Cap P/E
TARO 4.8 13% 91% 0.6 13% 11.7
TEVA 48.8 2% 18% -10.9 -22% 16.4
MYL 18.5 5% 7% -7.6 -41% 39.9
Click to enlarge

As you can see in the table, these three are closer in size; however, Taro still has a higher growth rate and a considerably better balance sheet. Yet, Taro trades at an even larger discount. If Taro traded at 28.1x earnings, the average of TEVA and MYL, it would imply a price of $257 - 140% higher than today's price.

Lastly, let's look at Taro vs. other dermatology-focused companies. Two comparables which happen to be in the news a lot recently are Valeant (NYSE:VRX) and Allergan (NYSE:AGN).

Market Cap Revenue Growth EPS Growth Net Cash on BS Net Cash as % of Mkt Cap P/E
TARO 4.8 13% 91% 0.6 13% 11.7
VRX 42.6 77% 82% -16.8 -39% n/a
AGN 47.0 13% -4% 1.5 3% 45.5
Click to enlarge

Here, the comparison gets a little more difficult. Valeant, a hedge fund darling, shows higher growth than Taro, but that is largely accomplished through acquisitions. While not presented on this table, it's important to note that Valeant is not profitable, largely from increasing interest expense as the debt balance has ballooned. Allergan is a closer comp to Taro - both have similar growth rates (at least top line) and both have net cash on the balance sheet. If Taro were to trade at the same multiple as Allergan, it would imply a price around $400.

So Taro is growing, cheap, has a clean balance sheet, but that isn't enough... as any good Seeking Alpha reader knows, cheap securities can stay cheap. So what will get the share price moving?

Taro is majority-owned by Sun Pharma. Sun would like nothing more than to own the entirety of Taro. Its most recent buyout attempt failed to get investor support, and was abandoned in February of 2013. Since then, Sun has looked for other ways to increase its ownership. Most recently, Taro announced a $200 million buyback (roughly 5% of market cap) in November of 2013. With that buyback complete and cash once again growing on the balance sheet, it doesn't seem extreme to expect another buyback announcement this summer, the initiation of a cash dividend, or possibly even another buyout attempt by Sun Pharma. The future remains bright for Taro, and despite the strong returns over the past two years, shares still offer tremendous value relative to other dermatology, OTC/generic, or large pharma companies.

Disclosure: I am long TARO. 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.