Elanco Animal Health: An Unnoticed Stock With Potential (NYSE:ELAN)

Summary

Elanco Animal Health Inc. is buying Bayer’s animal health unit.
Elanco has underperformed the overall market and rivals.
With new product launches, Elanco looks to grow revenue.
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Today more than ever, pet owners view their pets as irreplaceable members of their families and lives, and it's thanks to this that we continue to see such incredible growth within the pet care community. – American Pet Products Association

Elanco Animal Health Inc. (NYSE:ELAN) is set to become the second largest animal health company in the world when it closes a deal to buy Bayer’s (OTCPK:BAYZF) animal health business later this year. ELAN has severely underperformed its rivals lately but looks ready to jump ahead, and now is a good entry point.

One of Elanco's strengths is innovation and making new products successful. New products that were launched since 2015 now account for 14% of total revenue, which is a 60% jump from last year. Sales of these new products grew 65% in the 4^th quarter. The Bayer combination will give Elanco 25 new launches to add to its portfolio. Given their experience with managing new launches, management expects these to immediately add to sales and revenue numbers.

Another innovation Elanco is having success with is developing a physical retail and ecommerce store for pets in the US, instead of only selling through veterinarians. These alternative channels have more than doubled sales in the past two years as consumers like to take shopping and price into their own hands.

ELAN is currently trading at a PE ratio of 23.3, which is well below its historical average of 27.7. Compared to its rivals, it also looks cheap with Zoetis (ZTS) Inc. at 34.3 and IDEXX Laboratories (IDXX) at 54.4. Elanco’s 4^th quarter earnings were in line with estimates, even though they missed on revenue. One of the drags on revenue was the cost of exiting certain businesses. In order to buy Bayer’s unit, Elanco must divest of 4 products, which represent about $130 million of revenue. When removing these exit costs from 4^th quarter numbers, revenue actually grew by 1%. One of the highlights of 4^th quarter earnings was the turnaround in Food Animal revenue. This had declined the past several quarters but grew by 1.4% this quarter. Elanco is setting the stage for positive revenue and earnings growth in the future.

The biggest risk to the stock is the amount of debt the company is going to take on to buy the Bayer unit for $7.6 billion. This will be financed by debt and equity, which will leave the company highly leveraged. ELAN’s current debt/equity ratio is an easy 0.42, but after the purchase, it will jump to 1.7. This is high relative to ELAN’s past, but not compared to its peers. Zoetis has a D/E ratio of 2.4, and Merck (MRK) is at 1.0. Elanco has been reducing costs and does not pay a dividend, so it has less fixed costs. Its manufacturing cost savings for 2019 totaled $70 million.

Another benefit to Elanco is that the coronavirus has yet to spread to livestock or companion animals. In fact, the adoption of companion animals is estimated to be up 100% and fosters up 197% from last year, according to the Association for Animal Welfare Advancement. Even though there is a fear of people dumping dogs and cats during the coronavirus due to lack of funds to pay for it, we have yet to see it happen. Most of these dogs and cats that were adopted will become a part of their adopted family and will need veterinary care throughout their lives. And there has not been any widespread panic about beef, pork, or chicken potentially being tainted by the coronavirus.

Elanco is part of the healthcare sector which overall has survived the coronavirus downturn very well, and according to the Lead-Lag Report, “The chart pattern establishing higher highs following brief pullbacks indicates relative strength and good momentum in healthcare stocks.” At a current price of $23.85, the stock is ready to cross its 50-day moving average and is showing strength. This looks like a solid entry point into a stock that has a portfolio of products that can generate attractive revenue and sales.

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This article was written by

Michael A. Gayed, CFA

29.54K Followers

Michael A. Gayed is portfolio manager, and author of five award-winning research papers on market anomalies and investing. He has a BS with a double major in Finance & Management from NYU Stern School of Business, and is a CFA Charterholder. Michael runs the investing group The Lead-Lag Report, focused on helping investors outperform in all market conditions. It offers a tactical, data-driven approach to investing, to achieve long-term success even in the face of uncertainty. With increasing market volatility, it's essential to understand risk-on/risk-off signals, seize high-yield opportunities, and leverage award-winning research to maximize returns. Learn More.

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