I was shocked at a dinner in late December when a friend of mine, who manages $100mm+ in a style that one might describe as small-cap growth at a reasonable price, confided to me that he had just purchased AGN. At my former firm we had been long AGN since they closed on their purchase of our holding, Inamed, so, having experienced the sharp drop subsequent to that closing and then the complete recovery, I questioned his timing. While he admitted that it wasn’t as attractive as it had been, he pointed out that it is more important to focus on where it is going with its aesthetic franchise. While I think that my friend will prove right, I am not on board at this time – yet.
AGN is somewhat of a strange stock, with its coverage by the sell-side strikingly low given its size (just 9). I think that the reason for the sparse coverage is that the company is somewhat of a hybrid, which doesn’t really fit into Wall Street’s neat little partitioning of the Healthcare sector. Its roots are in ophthalmology, with an evolution into aesthetics (Botox) and now devices (the Inamed products). Botox (full disclosure: Neither I, nor any of my family members, use it) has always been somewhat seemingly under appreciated, especially on the therapeutic side. The CEO, David Pyott, who I believe is one of the best in the industry, has always been conservative and has tended to keep upside on the top-line from dropping down, as the company continues to invest extremely heavily in SG&A and R&D. The bulls, however, have a keen appreciation for the relative lack of exposure to reimbursement risk and to genericization of its products. And, while not a pure play, the demographic trends sure seem favorable for the company as well.
As you can see in this chart, the stock has stumbled of late:
To put things in perspective, though, this is purely a consolidation of an almost doubling of the value of the stock from the lows in early 2005. While in the chart above it has broken the long-term trend line (which is still headed up), it has held the 200dma, which a lot of people use rather than the 150dma that I favor. More importantly to me, however, is an analysis of the distribution of price and volume over the past year and past two years. The 114.50 area now looms as overhead resistance – that is the highest volume area over the past year.
In terms of support, volume is fairly evenly distributed at lower prices all the way down to 104 (which I will term as the price at which the Bulls begin to panic rather than worry). A look at the past two years shows a slightly different picture, with the greatest frequency of volume around 106.50, which is comforting that there should be support between here and there. If I had to guess, the 110 area may mark the bottom of this retracement.
I haven’t really answered the question in the title yet – what is going on here? I think that there are a number of issues, none of which are really reflective of the company’s longer-term prospects. First, the stock is pretty expensive by some measures. While I think that it deserves a high multiple given its long-term growth outlook, its lack of exposure to generic substitution and to Medicare reimbursement, strong management, great financials and earnings power that is masked by current high investment in the business, the stock trades at a strong 26X 2007 EPS and 22X 2008 EPS. This is a premium to the market, though EPS growth of 18-19% over the next two years is as well.
Traditionally, AGN commanded a premium to other Pharmaceutical stocks due to the factors I mentioned above (I am not the only one aware of the positives!). AGN was a great place to be over the past several years if you had to be in the sector. Last year, though, large-cap Pharma stocks did quite well. The popular Amex Pharmaceutical Index certainly wasn’t the life of the party, lagging the S&P 500 significantly, but some of the components have performed exceptionally (Merck (MRK), Abbott Labs (ABT), Bristol-Myers Squibb (BMY)) since the sector hit bottom. It’s no longer embarrassing to own them! Perhaps that’s the real reason that AMGN and especially DNA have stalled too. At any rate, as these large, non-growing companies have been experiencing a rebound, it has put some pressure on the growth names, like AGN, which, quite, frankly, had been getting a premium valuation. As you can see from the chart below, the DRG has been outperforming AGN lately, but AGN has left its sector in the dust over longer time-frames:
Looking at some other factors, I do recall that the company experienced some insider selling once Inamed closed, as there had been a rather long closed trading window during that transaction. I don’t see anything particularly alarming on that front. The top three holders held steady in Q4 at 28% of the company. I did note, however, that three rather large holders (Janus, Capital Guardian and Barclays Global) all began selling positions in Q4. The combined stock that they owned as of 12/31 was 10% of the company, and their continued sale may be the cause for the pressure on the stock.
I believe that AGN may find a bottom this quarter in the 107 to 112 area, with 110 serving as my best guess. I think that despite its high valuation in terms of PE, the stock should perform well over the long-term as its earnings growth offsets the PE compression that I would expect over time. I don’t believe that the company will always have to maintain such an expensive cost structure as it matures, which should allow them to experience EPS growth in excess of their healthy revenue growth in coming years. Stay tuned!
Disclosure: Author has no position in AGN.