Mylan: Deeply Undervalued On Unwarranted Approval Concerns

Aug.27.14 | About: Mylan Inc (MYL)


Mylan has a vast pipeline of generic drugs awaiting FDA approval.

Concern about the timing of approvals has depressed the stock price.

Patient investors are likely to see extraordinary returns in the next few years.

Mylan (NASDAQ:MYL) is a manufacturer of generic pharmaceuticals. It closed on Tuesday, August 25, 2014 at $48.30. I expect by the end of 2015 Mylan will have doubled to about $100.00, with a good chance of that happening sooner. I use the word "expect" in the probabilistic sense. 20% above or below the expected value would not surprise me. However, as usual there are many factors that could affect the price between now and the end of 2015.

Mylan has spent the last few years setting itself up for future success, only to hit a bottleneck at the FDA. Generic drugs must get FDA permission for market authorization, which entails mainly showing that the new generic is chemically equivalent to the name-brand drug it seeks to supplement. Generic drug makers must also show their manufacturing facilities, where ever they are in the world, are up to FDA standards. Mylan has brought all of its facilities up to FDA standards.

The bottleneck is mainly from the sheer volume of applications being made by generic drug companies, combined with inadequate FDA staffing due to budget cuts by Congress. At last count Mylan had about 300 ANDAs (abbreviated new drug applications) pending with the FDA. As a global company it also typically has to get approvals in every country where it sells drugs.

There can also be delays in introducing generic drugs because of litigation, usually over patents, by the name-brand drug makers. This can cause both expected and unexpected delays, but Mylan and other generic drug makers have always had to deal with this issue.

These delays, in particular for a generic equivalent of Copaxone, have caused some analysts to question Mylan's ability to grow, which in turn had depressed the price of the stock. However, Mylan management has emphasized that it does not expect any of its ANDAs to be ultimately turned down by the FDA. Growth is coming, the only question would be the timing of the growth. That is why I don't feel confident about making predictions for the end of 2014, but I am reasonably confident about where Mylan will be by the end of 2015.

Because of the uncertainty, on August 7 Mylan narrowed its full 2014 guidance, with most of the narrowing coming off the top end. Even so, revenue is expected to be between $7.8 and $8.0 billion, with Non-GAAP EPS of $3.25 to $3.45. Given the uncertainty, I will use the $7.8 billion revenue figure and $3.25 adjusted EPS figure for argument's sake. A quick calculation gets us Q3 and Q4 numbers, assuming Q3 and Q4 have equal results (in reality, Q4 is likely to be a ramp from Q3):

Period of 2014 Revenue, $ Billions adjusted EPS, $
Q1 1.72 0.66
Q2 1.84 0.69
Q1 + Q2 3.56 1.35
Full year guidance 7.8 3.25
H2 4.24 1.90
Q4 (or Q3) 2.12 0.95
Click to enlarge

Relying on Mylan's guidance, but taking it conservatively, the non-GAAP EPS run rate entering 2015 would be $0.95. That would be 44% higher than Q1 2014. Again going conservative, I am willing to "expect" (in the statistical sense) non-GAAP EPS to be 30% higher in 2015 than 2014.

Given that level of expectation, I would expect by the end of 2015 that the trailing non-GAAP EPS (including Q4 2015) would be 1.3 x $3.25, or $4.23 per share. If that ends up on the mark, and the stock has also hit my prediction of $100 per share, non-GAAP trailing P/E would be 23.6, which would be within my rule of thumb for a company growing profits rapidly.

Again, my only question would be timing. If FDA approvals and drug launches come even slower than expected, it would take longer to reach the $100 mark. If FDA approvals come more quickly, then we could see MYL at $100 per share some time earlier in 2015.

In its drive for global generic supremacy Mylan has racked up $7.9 billion in long-term debt. In the latest quarter interest expense was $84.6 million, which is not trivial sum. Mylan's management has shown a willingness to borrow to acquire key assets. I see this debt, and the interest on it, as the greatest single danger to Mylan (which is not the same as saying it was unreasonable for management to take on the debt).

But how dangerous is that debt, really? For the first half of 2014 cash flow from operating activities was $559 million. Annualize that to about $1.1 billion, and so the debt seems payable. If the debt is reduced over time, that would increase EPS. But clearly Mylan uses a leveraged growth model.

Given the debt, it could be argued that the P/E calculated above is generous, and so my $100 per share guess is generous as well.

The other risks for Mylan are typical regulatory, competitive, and macroeconomic risks. There is the usual risk from a stock market correction. Mylan currently dominates the epinephrine auto-injector market with its EpiPen®. A decrease in demand (as perhaps people stockpile the pens, instead of using them) could be a risk. But because Mylan sells so many generic products, other than EpiPen it is unlikely that a drop in revenue from any single product would have a meaningful impact on the stock price.

On the upside, Mylan is in a position to sell biosimilars at whatever point the FDA begins approving them.

Finally, having heard my guess at 2015, you should be aware of Mylan's predictions for 2018.

Mylan's management believes that adjusted diluted EPS in 2018 will be at least $6 per share. At a P/E of 24, that would put Mylan at $144 per share. Most traders are too busy making short term trades to buy an under-$50 stock and wait 4 years for it to hit $144, but that kind of opportunity looks sweet to me.

Disclosure: The author is long MYL.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.