In this article, I will run you through my DCF model on Amgen (AMGN) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Abbott (ABT) and Teva Pharmaceutical (TEVA). I find that these companies are significantly undervalued.
First, let's begin with an assumption about the top-line. Amgen finished FY2011 with $15.6B in revenue, which represented a 3.5% gain off of the preceding year: acceleration. I model growth trending from 4% to 1% in the 2014 - 2016 period and then bounding back to 3%.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold eating 14.8% of revenue versus 18.5% for SG&A, 20% for R&D, and 4.5% for capex. Taxes are estimated at 15% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model).
We then need to subtract out net increases in working capital. I expect this to hover around 1% of revenue.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $92.59, implying 36% upside. DCF models are often criticized for the "discount" part, so it is important to consider the sensitivity of the input figures. My sensitivity analysis that considers a variety of perpetual growth and WACC inputs yields a standard deviation of $13.14 - 14.2% of the intrinsic value result. This indicates that the DCF model is reliable in this instance.
All of this falls within the context of strong momentum:
"As you've seen from our results for the fourth quarter, we ended the year with momentum, and we expect 2012 to be even stronger. I'll touch on some of the highlights. We entered 2012 with our Neulasta franchise growing, with Enbrel maintaining its market leadership and more stable outlook for EPOGEN, particularly now that we have long-term contracts in place. Prolia and XGEVA are obviously the important part of our outlook for 2012 and beyond".
From a multiples perspective, Amgen is equally attractive. It trades at a respective 16.8x and 10.1x past and forward earnings versus 20.5x and 11.5x for Abbott and 14.5x and 7.4x for Teva. Assuming a multiple of 14x and a conservative 2013 EPS of $6.65, the rough intrinsic value of Amgen's stock is $93.10 - virtually in-line with my DCF result. What's more, the historical 5-year average PE multiple of Amgen is 14.2. The historical 5-year average low PE multiple is 11.7. Amgen only requires 10.1x to appreciate!
Consensus estimates for Abbott's EPS forecast that it will grow by 7.5% to $5.01 in 2012 and then by 6.6% and 5.2% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $73.92, the rough intrinsic value of the stock is $73.92, implying 20.6% upside. The company delivered strong performance in 2011 with sales growth of 10% and double-digit momentum in a variety of segments. HUMIRA, in particular, has done far better than what I expected.
Teva is similarly significantly undervalued. Consensus estimates are that its EPS will grow by 12.7% to $5.60 in 2012 and then by 8.2% and 7.4% in the following two years. Assuming a multiple of just 11x and a conservative 2013 EPS of $6, the stock will rise 46.5%. Investors have overly lamented the slow momentum in generics. I am optimistic about the company's M&A strategy exciting back investors. Towards that end, management's hiring of Jeremy Levin as CEO, who comes with a history of overseeing takeovers at Bristol Myers (BMY), is a solid step in the right direction. It is thus only a matter of time before Teva's multiples return to normalized industry levels.
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