Biotech is one of the few industries out there that is attractive to value investors (especially, shareholder activists), income investors, and defensive investors. Small firms can become giants almost overnight and titans stay defensive with high dividend yields and an inelastic demand. Over the last few months, Mylan (MYL) has been some gaining ground against its larger biotech competitors, Johnson & Johnson (JNJ) and Novartis (NVS). Based on earnings potential and pricing upside, I expect the firm to go skyward.
From a PE perspective, Novartis appears to be the cheapest of the three. It trades at a respective 13.6x and 10.2x past and forward earnings. Mylan and J&J trade at a respective 9.1x and 12.5x forward earnings. Novartis also offers the highest dividend at 4.2% compared to 3.5% for J&J and 0% for Mylan. Perhaps this is the reason why Novartis is rated closer to a "strong buy" than its competitors are. On the other hand, J&J has a solid net cash position of $12.6B, 7% of market value, that can be used for M&A growth. Novartis and Mylan have net debt at 13.3% and 51.3% of market value, respectively. But the story now at hand is that Mylan has appreciated by 34.5% over the last three months, dwarfing the 4.4% rise for Novartis and 5.3% rise for J&J.
At the third quarter earnings call, Mylan's Chairman, Robert Coury, noted solid performance:
"[W]e once again delivered a strong quarter of top line and bottom line growth, and continue to benefit from the scale and diversity of our global platform. Revenues in the third quarter were up more than 16% over the same quarter in 2010. Adjusted earnings per share grew 28% over last year, coming in at $0.55 for the third quarter. While the vast majority of our business performed well this quarter, I particularly want to highlight the strong performance by our specialty subsidiary Dey Pharma. As a result of an impressive execution by Dey, this business has really begun to accelerate and continues to be an important growth driver for Mylan, one in which we will build upon. In other developments at Dey, the U.S. Patents and Trademark Office recently issued re-examination certificates for 2 patents relating to our performance product. Sepracor, now known as Sunovion Pharmaceuticals, have requested the Patent and Trademark Office to re-examine these patents, and with the process now complete, the validity of these patents has been reaffirmed".
A nice surprise for the biotech firm was the FDA approval for metroprolol succinate ER, gTropol XL - part an undisclosed pipeline. Sales in brand and generic were $1.2B through November 2011 and the product may be about 3.5% accretive to 2012 EPS. While the acquisition of Pfizer's (PFE) generic respiratory platform and greater R&D will dilute immediate earnings, the strategic efforts represent a step in the right direction to long-term value creation. In particular, investors have not fully appreciated the new control of Advair, which came with the acquisition - this drug has an annual run-rate of $8B. And in geographic performance, Mylan is well positioned. Japan upside will offset the 23% price cut in Australia and high single-digits are guided for Asia. Even EMEA, despite macro headwinds, will be supported by new products and complements. The market has already anticipated erosion in these regions, which has set the bar low.
Consensus estimates for Mylan's EPS are that it will grow by 24.8% to $2.01 in 2011 and then by 18.9% and 7.9% more in the following two year. Assuming a multiple of 15x and a conservative 2012 EPS of $2.33, the rough intrinsic value of the stock is $34.95, which implies substantial upside. If the multiple were to decline to, say, 10.5x and 2012 EPS turns out to be an absurd 13% below consensus, then the firm would be a safe investment.
I am similarly bullish on Novartis, despite recent setbacks. The company terminated its ALTITUDE study for Tekturna, a blood pressure drug due to the lack of efficacy and increased adverse events. BCR-ABL sales will grow at a CAGR of around 1% to 2015, as competition sets in. On the other hand, the market has exaggerated and set the bar low due to the impact of the expiration of U.S. Diovan patent and Sandoz competition in 2012. Gilenya will drive new products and help save costs, margins are improving overall, and the company has leading operational excellence.
Consensus estimates for Novartis' EPS are that it will grow by 7.2% to $5.52 in 2011 and then by 3.3% and 1.8% more in the following two years. Assuming a multiple of 15x and a conservative 2012 EPS of $5.65, the rough intrinsic value of the stock is $84.60, implying considerable upside. Even if the multiple were to decline to 11x and 2012 EPS turns out to be 7% below 2012 EPS consensus - and even below the 2011 EPS consensus - the stock would still be safe.
I am most conservative about J&J. Xarelto may not meet expectations, although the consumer segment is indicating strong demand. As I argue here, Xarelto is not a cure for pipeline and macro concerns, which include: a lack of product diversity, little R&D, Eliquis competition, and dependency on Europe. While the firm is still an attractive defensive investment, it is less of a value play, in my view.
Consensus estimates for J&J's EPS are that it will grow by 4.4% to $4.97 in 2011 and then by 5.2% and 7.3% more in the following two years. Assuming a multiple of 15.5x and a conservative 2012 EPS of $5.19, the rough intrinsic value of the stock is $80.45, implying meaningful, but limited, upside.