Biotech is, in my view, one of the strongest sectors to back. From revenue catalysts to takeover activity and high dividend yields, the risk/reward is just right. In this article, I will run you through my DCF model on Mylan (MYL) and then triangulate the result with a review of the fundamentals against Teva Pharmaceutical (TEVA) and Pfizer (PFE). I find that Teva and Pfizer are more undervalued right now.
First, let's begin with an assumption about the top-line. Mylan finished FY2011 with $6.1B in revenue, which represented a 12% gain off of the preceding year. I model growth trending around 12% over the next half decade or so.
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 as 59% of revenue versus 20% for SG&A, 5.1% for R&D, and 4% for capex. Taxes are estimated at around 14% 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 to get free cash flow. I estimate this figure hovering around 1% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 9% yields a fair value figure of $24 for ~9% upside. The company trades reasonably around 8.9x my 2016 free cash flow estimate.
All of this falls within the context of strong operating performance:
"Our diverse global platform has once again delivered strong results, representing a great start to 2012. Double-digit growth on our North American, Asia-Pacific and Specialty businesses allowed us to deliver robust financial results despite persistent macroeconomic headwinds in certain regions, specifically Europe and Australia. We are reaffirming our 2012 guidance of $2.30 to $2.50 per share and we see opportunities for upside during the year. Further, the strength of our platforms, first-in-class science and robust product portfolio give us continued confidence in our long-term growth target for 2013 and beyond".
From a multiples perspective, Mylan is also attractive. It trades at 18x past earnings but only 8.3x forward earnings. This compares to corresponding figures of 14.8x and 7.5x for Teva and 21x and 9.8x for Pfizer.
Consensus estimates for Teva's EPS forecast that it will grow by 12.9% to $5.61 in 2012 and then by 7.8% and 6.4% in the following two years. Assuming a multiple of 9.5x and a conservative 2013 EPS of $6, the stock would hit $57 for 24.9% upside. A few months back, the company elected Jeremy Levin from Bristol Myers (BMY) as CEO. Levin has a background in takeover activity, and I expect him to bring this focus to Teva in order to take focus away from generics and towards catalysts.
Consensus estimates for Pfizer's EPS forecast that it will decline by 2.2% to $2.25 in 2012 and then grow by 4% and 3.8% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $2.32, the stock would hit $30.16 for 30.7% upside. While many bears have stressed the company's patent cliffs, the company still retains a strong brand and can easily unlock revenue synergies from takeover activity. Accordingly, I am very optimistic about the firm's future.
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