I've discussed Allergan's (NYSE: AGN) various businesses from a qualitative and quantitative prospective, and it’s clear that I like the company’s long-term strategy and its presence in the aesthetics market.
I believe Allergan is one of the best positioned companies in the pharmaceuticals space and worthy of long-term investment. However, I think some profit-taking on the name would make sense at this time.
In fact, after the strong performance in the last two months and a 25% move off its lows, a valuation check suggests that the risk/reward is much less compelling than few months ago.
Thus, in this article, I will go through three valuation approaches — DCF, sum-of-the-parts (SOTP), and multiple comparison — to demonstrate why I believe it’s time to take profits in Allergan.
I discussed here the methodology behind my DCF Valuation for Allergan. In this article, I update my analysis on the basis of the announcements of FY 2016 Results and of the recent acquisition of ZELTIQ.
Here are my key assumptions for the estimates of Sales, EBITDA Margin and FCF:
Source: Bloomberg & My Own Valuation Model
As you can see, these estimates are below consensus. Specifically, I assume a lower EBITDA margin compared to sell-side estimates for 2019-2022, because I think the Street has overlooked the profitability dilution from the recent acquisition of ZELTIQ.
Source: Consensus Comparison vs. My Own Valuation Model
To generate a DCF Analysis, I used 2 different methodologies:
- PERPETUITY GROWTH METHOD: I used conservative assumptions about the perpetual growth rate and the WACC. In details, I used a perpetual growth rate of 1%, which is lower than Bloomberg assumption (i.e. 2%) and I assumed a WACC of 7.5%, that is higher than the Bloomberg estimate (i.e. 7%).
As can be seen in the table above, Allergan is undervalued by only 13% based on the Perpetuity Growth Model, while in my previous analysis it was undervalued by around 40% on similar assumptions.
- EBITDA MULTIPLE METHOD: this analysis reveals a slightly worse result for Allergan's valuation, because the company looks undervalued by only 4%, which looks less attractive compared to my previous analysis where it was undervalued by about 30%. I still assumed an EBITDA exit multiple of 12x, which is in line with Allergan’s historical EV/EBITDA valuation, as shown by the following tables:
Source: Allergan's Current vs. 5-year average EV/EBITDA (absolute analysis) - Bloomberg
On December 2016, I discussed here why I was convinced that the market was missing the value of the Botox/Aesthetics Franchise for Allergan and I used a SOTP (Sum of the Parts) Approach to support my thesis.
I have updated my analysis to show what multiple is now implied in the current 14x P/E 2018 valuation of Allergan, using a SOTP in order to classify Allergan's key drugs in 3 buckets and making the assumptions that Legacy Brands is composed by declining drugs with the highest profitability.
- Durable brands (Botox/Aesthetics) + LifeCell and ZELTIQ businesses
- Branded Pharma/Recent Launches (Eye Care, Dermatology, GI + recent launches as Viberzi, Vraylar, etc.)
- Legacy Brands (Namenda, Minastrin, Asacol, Bystolic, etc.)
Source: My Own Valuation Model
There are two takeaways from this analysis:
- Assuming that the market will fully recognize the value of AGN’s Aesthetics franchise (i.e. 22x P/E 2018), the company is undervalued by only 10%, while in my previous analysis (based on 2017 numbers) there was more than 20% of upside.
- The implicit multiple that the market is assigning to the Aesthetics franchise is now 18x on 2018 P/E, while in my previous analysis it was only 14x on 2017 numbers. Thus, it’s not anymore true that market is totally missing the quality of Botox/Aesthetics franchise, as I discussed in my previous article.
Lastly, in my previous analysis, one key element behind my bull thesis on Allergan was that the company was trading at only 12x 2017E EPS, which was at the low end of the diversified biopharma group, despite a highly attractive portfolio of assets.
Today, Allergan isn’t anymore trading at discount to 5 years average historical P/E on an absolute and relative basis, as shown by the following analysis. In particular, the stock is trading at 15x NTM (next twelve months) P/E, which is at slightly premium to its historical P/E valuation.
Source: Allergan's Current vs. 5-year average P/E (absolute analysis) - Bloomberg
Source: Allergan's Current vs. 5-year average P/E & EV/EBITDA (relative analysis vs. Spec Pharma peers) – Bloomberg
If you've read my previous article, you know I love Allergan's business model. I believe the use of the cash received from Teva (NYSE:TEVA) by the management has been good, and I think FY17 guidance is conservative and encouraging.
Despite that, as shown by this quantitative analysis, the risk/reward on the name is much less compelling than few months ago.
If the management will be able to achieve results at least in line with consensus for the next couple of years, there will be only around 10% upside for the stock.
In addition to that, the market has rewarded the presence of Allergan in the Aesthetics franchise, as suggested by the fact the company has closed the valuation gap with the peers over the past 2 months.
Thus, I would take some profit on the stock, waiting for a better entry point later during the year.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.
Additional disclosure: Not investment advice. I am not an investment adviser.