In a world where doing a little bit of everything has become popular among drug companies, Mylan (MYL) has stuck to its guns. Unlike Teva (TEVA) and Sandoz (part of Novartis (NVS)), Mylan really is just about generic drugs and the opportunity to leverage one of the largest global franchises in that segment of the drug market. At the bottom line, Mylan is an interesting investment prospect, but really needs to deliver more to be a top choice.
Ending The Year In Line
Mylan did not offer a lot of surprises to close this fiscal year. Revenue rose about 7%, with generics up about 5% overall and the small (less than 10%) specialty business up almost 38%. The generics business was definitely a haves-and-have-not situation this quarter, as the North American business grew almost 13% on good volumes and strong pricing, while the European business saw revenue drop 12% on weak pricing.
Margins weren't terribly surprising either. Gross margin improved about a point and operating income rose almost 12% on an adjusted basis.
Sticking To Its Knitting
While Teva and Watson (WPI) have shown relatively more interest in building branded drug businesses, Mylan has been much more focused on its generic drug business. Acquisitions in Europe and Asia have given the company the global reach it needs, with Latin America (and Brazil in particular) arguably the only area that really needs expansion.
Along with geographical expansion, Mylan has been quietly picking up bolt-on businesses here and there - acquiring respiratory assets from Pfizer (PFE), dermatology assets from Valeant (VRX), and so on. This has given Mylan some profitable niches in specialty generics where there isn't nearly so much competition.
Riding The Last Big Wave...
Mylan is also prepping to make the most of the last big wave in Big Pharma patent expirations for a few years. Multi-billion dollar drugs like Pfizer's Lipitor and Forest Labs' (FRX) Lexapro go generic this year, as do Diovan and ActoPlus, and Mylan should be able to ring up some solid sales from windows of limited exclusivity and competition.
This is likely the last of the ripe pickings for some time to come. While it's true that patent extensions have extended the lives of a few compounds, the overall outlook for patent expirations in 2014-2016 isn't as strong as 2011-2013, so Mylan needs to book the profits when it can.
And Paddling Out For The Next
While the conventional generic pipeline may be thinning a bit, the biosimilars opportunity is just beginning. Biosimilars are basically generic version of biological drugs like monoclonal antibodies and recombinant proteins. This category includes includes major blockbuster drugs like Abbott Labs' (ABT) Humira, Johnson & Johnson's (JNJ) Remicade, and Amgen's Enbrel and Epogen, and the FDA has taken significant recent steps to clarify the process for getting biosimilars of these drugs to market.
Unlike conventional drugs, biosimilars are not easy to create or manufacture and it is probable that companies that can crack the code will enjoy solid pricing on par with protected generics (which often sell for 50% of branded drug prices, as opposed to regular generics which generally sell for less than 10% of the original branded list price).
Certainly Mylan is not alone here. Every major generic company is also looking to become a major biosimilar company and rivals like Teva and Watson have teamed up with Lonza and Amgen, respectively, to address the market. Unconventional names (at least unconventional for the generics biz) are also looking to get into the act, with companies like Baxter (BAX) and Hospira (HSP) forming partnerships and developing their own capabilities. While Mylan has its own partnerships (with Biocon and Natco), it wouldn't shock me to see the company consider a bid for the likes of Momenta (MNTA) (which is working with Baxter) at some point down the road.
The Bottom Line
Mylan has thus far resisted the siren song of further investment in specialty/branded pharmaceuticals, even though its EpiPen has been quite successful in its niche. Although I applaud management focus in this regard, it still won't surprise me if the day comes when there's an announcement of a small branded/specialty pharmaceutical business - particularly if its in a well-defined niche like dermatology or eye care.
What Mylan needs to do now is make more from what it has. The company has a global platform and valuable niche business and its time to leverage that into better overall free cash flow conversion. On a trailing basis, Mylan is about two-thirds as efficient as Teva in creating free cash flow. This gap needs to close for the stock to really thrive.
As it stands today, I see fair value in the upper mid-$20s; undervalued enough to hold, but not enough to move me towards this stock in favor of Teva or other cheaper names in pharmaceuticals and healthcare at large.