What follows is a list of healthcare companies with various degrees of upside. They cover a variety of industries from biotechnology to medical devices. In my view, Teva is the most undervalued due to how investor fatigue based on past performance is neglecting future streams of free cash flow. The firm is heading in the right direction and is already undervalued based on the current fundamentals. St. Jude is also attractive due to its catalysts while Watson even has double-digit upside. I rate Teva and St. Jude "buys"; Watson, "hold"
Teva Pharmaceutical (NASDAQ:TEVA)
To value Teva, I employ a DCF model. In this model, I make several assumptions: (1) 8.5% per annum growth over the next half decade or so, (2) operating metrics stay at historical levels, (3) a 2.5% perpetual growth rate, and (4) a discount rate of 9%. Based on these assumptions, I find that the stock's intrinsic value is $61.33, implying incredible upside.
After the steep sell off in early May, I am optimistic about the risk/reward story going forward. In particular, I believe that the hiring of Jeremy Levin from Bristol-Myers will help the firm optimally restructure recent acquisitions into a coherent model. While the dividend yield of 2.5% is weak, the stocks, 0.3 beta and 12.1x PE multiple limits downside.
Bristol-Myers trades at a respective 14.7x and 17.1x past and forward earnings with a dividend yield of 4.2%. To value Bristol, I employ a DCF model. In this model, I make several assumptions: (1) 1% per annum growth over the next half decade or so, (2) operating metrics stay at historical levels, (3) a 2.5% perpetual growth rate, and (4) a discount rate of 9%. Based on these assumptions, I find that the fair value of Bristol is $42.12.
With my growth assumptions already pretty low, I believe that Bristol's risk/reward is highly compelling and rate the stock a "buy". From targeting inelastic demand to providing a high dividend yield, the downside case remains structurally limited. Investor fatigue has only set the bar lower than what it should have been, which will allow for abnormally high returns.
Emergent Health Corp (OTCPK:EMGE)
Emergent is a producer in regenerative medicine - a niche industry that the US Department of Health anticipates being a prime beneficiary of demographic trends in medicine. This federal agency is specifically forecasting that (1) an aging population will drive healthcare costs and (2) seniors will have the greatest need for regernative medicine. Fortunately, Emergent has an active pipeline to capitalize off of these secular trends. Innovation is complemented by solid IP protection.
The stock fell substantially near the end of trading on June 5th in sharp contrast to the fundamentals. Emergent has traded at around 8x the current price for the year while the long story improves. It has recently launched a new Anti-Aging product that improves health quality and stem cell vitality. More than increasing revenue in and of itself, this offering enables cross-selling opportunities with Emergent's Stem Cell JDI MultiVitamin-MultiMineral offering. With shares at a low, I am optimistic that further momentum will recover lost value.
Watson Pharmaceuticals (WPI)
To value Watson, I employ a DCF model. In this model, I make several assumptions: (1) 12.5% per annum growth over the next half decade or so, (2) operating metrics stay at historical levels, (3) a 2.5% perpetual growth rate, and (4) a discount rate of 10%. Based on these assumptions, I find that the stock's intrinsic value is $85.51. While the upside is lacking, so is the safety. The stock currently trades at a PE multiple of 33.1x and has no dividend yield.
With that said, management has delivered strong momentum. First quarter 2012 results were excellent with revenue growing 74% and strategic integration of Ascent. I am also optimistic about the revenue and cost synergies that will emerge from the recent 4.25B euro Actavis Group buyout. Actavis offers more than 1K product with 300 under development. The firm is now the leading in generics in Southeast Asia.
St. Jude Medical (NYSE:STJ)
St. Jude trades at a respective 15.8x and 10.6x past and forward earnings with a dividend yield of 2.4%. Consensus estimates forecast St. Jude's EPS growing by 5.8% to $3.47 in 2012 and then by 6.3% and 8.9% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $3.62, the stock will hit $47.06 for 20% upside.
The stock is safe given that it is 30% less volatile than the broader market. St. Jude operates in the niche market of medical devices and thus is directly exposed to positive secular trends in technology. I am attracted to the firm's renal denervation system, which is a multi-billion dollar catalyst. Just a 4% penetration into the global market would yield upwards of $30B. With so many value levers to pull, St. Jude's multiples have upward momentum.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: The distributor of this research report, Gould Partners, is not a licensed investment adviser or broker dealer. We are a consultant to Emergent Health Corp and have received $10,000 for independent research. Investors are cautioned to perform their own due diligence as information contained within this report has been derived from public sources and cannot be guaranteed by us to be fully accurate. Always discuss investments with a licensed professional before making any financial decision. Statements made herein are often "forward-looking statements" as defined under Section 27A of the Securities Act of 1933, Section 21E of the Securities Act of 1934, and the Private Securities Litigation Reform Act of 1995. Since these statements are uncertain, actual results may be materially different from those expected.