3 Reasons Allergan Will Bottom

Summary

• Allergan stock is trending near yearly lows but the bearishness is questionable.
• Generic competition and LOE are manageable.
• Three considerations include: 2017 achievements, 2018 outlook and more.

At its current valuation of 8.7 times forward earnings, markets appear to under-estimate Allergan’s (NYSE:AGN) fair value. The company inked its deal to sell its generics division to Teva Pharmaceuticals (TEVA) for $40.5 billion in July 2015. Last November 2017, it began selling a quarter of its Teva shares. With a strong balance sheet and falling debt, what, then, is triggering Allergan’s fall on the stock market? The usual question value investors will ask is if the stock bottomed yet.

There are four things investors should consider.

1) 2017 Achievements

Allergan built its cosmetics and beauty business by acquiring the Regenerative Medicine and CoolSculpting business. Complementing its growth through acquisitions is its $15 billion share buyback and debt reduction of $2.9 billion:

Source: Allergan

For the full-year 2017, Allergan’s revenue grew 9 percent, non-GAAP net income rose 21 percent to $16.35 a share and cash flow from operations totaled $5.9 billion. Bearish investors may have higher expectations in the company’s outlook. Allergan faced two headwinds in 2017. First, its revenue from other products, its source of growth, was at a flat to single-digit decline:

Source: Allergan

Per above, Allergan’s outlook for promoted brands last year was strong since it expects organic growth in the high single digits.

LOE brands declined:

2) Allergan Not Just the Botox Company

Allergan must shake off the notion that it is just a Botox company. In Q4, Botox sales grew 16 percent and added $118M in revenue. In Q4, botox revenue grew 20% year-over-year but Juvederm grew 28% Y?/Y while Ozurdex grew 17% YY. The Regenerative Medicine/CoolSculpting unit added $256M in revenue. Recall that on Apr. 28, 2017, Allergan paid $2.4 billion for Zeltiq, or 10x 2017 sales. On the flipside, exclusivity losses in Aczone, Namenda XR, and Asacol HD/Delzicol Minastrin weakened Q4 sales growth to +12 percent.

IBS, or irritable bowel syndrome, is a market that is anchoring Allergan’s GI unit. Linzess reached $700 million in revenue in 2017. Viberzi will grow this year as TRx stabilizes:

Source: Allergan

Eye Care is another area for Allergan. Though Restasis revenue stabilized, drugs for Glaucoma and Retina should do well this year. Note that Allergan’s play in GI and eye care looks a lot like that of Valeant Pharmaceuticals (VRX) at a high level. Valeant’s debt ratios will still scare off conservative investors. Allergan actually has more debt than Valeant at $30.1 billion but a better debt / adjusted EBITDA:

Source: Allergan

There are, of course, stark differences between the two companies. Salix’s Xifaxan sales will be lumpy in the short-term as the sales team build their relationship with health care providers and establish their marketing channels.

AGN data by YCharts

3) 2018 Outlook and Risks

Allergan forecasts revenue in the range of around $15 billion in 2018. Gross margin, which includes the impact of LOEs, will be in the range of 85.5 percent – 86.0 percent. For Q1, EPS will top $3.20 - $3.40 a share on revenue of $3.5 billion - $3.6 billion.

Despite the conservative outlook that should stabilize the share price, markets are likely most fearful of Allergan’s Loss of Exclusivity (“LOE”). In 2017, $3 billion worth of product faced LOE exposure. For 2018, the company forecast significant declines as markets introduce generics. To offset the revenue decline, Allergan will cut 2018 expenses by $400 million.

Using the 5-year DCF Growth Exit model, assume 3 percent revenue growth:

Source: finbox.io (click on the link to change revenue assumptions)

Assume capital expenditures shrinking to 2.3% growth this year and beyond:

Source: finbox.io (click on the link to change CapEx assumptions)

At a discount rate of 9 – 10 percent, AGN stock has a fair value around $173:

Source: finbox.io

Note that the fair value varies dramatically with a lower discount rate. The price target rises to $213 when the mid-point discount rate is 9.5 percent:

Takeaway

The bottom in AGN stock is anyone’s guess but at these levels, value investors should consider building a position. Pricing pressures from generic competition are manageable. Debt reduction also cuts leverage risks for investors as Allergan aggressively buys back shares at current levels. Just as Valeant and Teva Pharmaceuticals (TEVA) are de-levering, Allergan is, too. Allergan will cut Q1 debt by $4.2 billion. By the end of this year, debt/adjusted EBITDA will fall to 3.3 times.

Analyst’s 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.