My Most Bearish Valuation Of Lannett

| About: Lannett Company, (LCI)

Summary

Bearish DCF valuation of LCI still points to 19% upside.

Multiple analysis puts LCI as the most attractive generic drug maker.

I suggest buying LCI at the $25 level.

I have looked into Lannett (NYSEMKT:LCI) for some time now and have been in the stock previously. Before I get to the risk associated with the stock, let me just highlight current valuation metrics (1 year forward metrics in brackets):

  • P/E = 6.06 (7.46)
  • EV /Sales = 1.71 (1.25)
  • EV/EBITDA = 3.00 (2.79)

Source: Factset as of June 22, 2016

Obviously the metrics above point to significant risk going forward, and/or historical troubles at the company, otherwise a low valuation like that would not exist in current market conditions. It's true that LCI's acquisition of Kremer has seen significant challenges, including loss of key customer after acquisition, higher cost of integration, and expensive financing, partially through 12% senior notes.

However, the latest news releases out of LCI have been positive, with statements on lost revenue of key clients at least partially being replaced with talk of LCI developing generic insulin with a Chinese partner, and the repurchase of the 12% senior notes, which will result in $170 million of interest savings through 2023.

This is in my view what has caused the upward movement from around $17 to approx. $25, where shares are today. In my valuation below, I will try and make the most bearish valuation of LCI I can imagine feasible.

DCF valuation

I assume the following in my bearish DCF valuation of LCI:

  • Sales growth of 3% per year after Kremer integration (2% in terminal period), far below their 31% CAGR from 2011-2015
  • No recovery in EBIT margin, i.e. estimated ~39% in 2017 and forward compared to 56% pre-Kremer, and also no synergies realized
  • WACC of 11%, i.e. assuming no benefit from the repurchase of 12% notes/refinancing

The above assumptions give the following DCF overview of valution:

Click to enlarge

As you can see above, if we assume virtually inflation level growth in revenues, no margin recovery, no synergies and high WACC, LCI is currently 19% undervalued.

I argue that margins could see significant upside to at least 40-45% range and WACC going 1-2pp lower following refinancing and ongoing delevering. In the sensitivity analysis below and improvement in terminal period EBIT-margin as well as lower WACC would push fair value of LCI close to $40 per share, representing +60% upside.

Multiples

As a sanity check I do a multiple analysis to see how LCI is valued compared to an international peer group and in particular how it is valued against Endo International (NASDAQ:ENDP) and Teva Pharmaceutical Industries (NASDAQ:TEVA) as other generic drug makers.

Click to enlarge

Source: Factset on June 22nd, 2016

As can be seen above, LCI is roughly 50-75% undervalued compared to the peer group and also undervalued compared to other generic drug makers.

Conclusion

LCI has gone through some rough months, with a poor start to the integration of their acquisition of Kremer. However, latest news out of LCI points to the worst being behind them.

Even when putting on bearish glasses and assuming low revenue growth and no recovery in margins and high WACC, LCI is undervalued.

DCF and multiple valuation points to 20-60% upside from the $25 level.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in LCI over the next 72 hours.

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.