Regeneron Pharmaceuticals: Undervalued Cash Generating Machine

Summary

• REGN has a strong economic moat protected by technology and patents.
• Profitability and strength of balance sheet are well above industry average.
• Market is overestimating the impact of tapering sales of their COVID treatment and potential biosimilars to Eylea.
• Current stock price offers 60-140% upside.

yalax/iStock via Getty Images

Investment Thesis

Regeneron Pharmaceuticals (NASDAQ:REGN) is a biotechnology company with commercialized medicines and treatments for eye diseases, allergic and inflammatory diseases, cancer, and cardiovascular diseases. REGN presents a great opportunity for investors because:

1. The market is overestimating the impact that lower REGEN-COV treatment and Eylea sales will have on future revenue.
2. REGN has strong economic moat protected by its technology and patents.
3. They are a highly profitable company with an exceptional balance sheet and a pile of cash.

Severe undervaluation of REGN

I believe REGN is severely undervalued by the market at this point. On every relevant valuation metric, it's far below the sector median: P/E ratio at 10.31, EV/Sales at 4.74, and Price/Sales at 4.93. REGN has recognized $2.9 B in sales for their monoclonal antibody cocktail REGEN-COV (US)/Ronapreve (international) for COVID-19 treatment, which accounts for 23.8% TTM of their sales. I believe that the market sees the promise of other COVID-19 treatments (e.g., Merck's COVID-19 pill) and the winding down of COVID-19 in sight, and is punishing REGN stock in anticipation of lower REGEN-COV sales. However, REGEN-COV sales are likely to persist into the near future. In September REGN signed a $2.9 B agreement with the US government to deliver an additional 1.4 M doses through January 2022, and a week later the World Health Organization issued a conditional recommendation for the use of REGN/Roche (OTCQX:RHHBY) Ronapreve. I believe the market is also eyeing the 2024 expiration of the initial Eylea formulation patent, and anticipating that a potential biosimilar would hurt Eylea sales, which accounted for 58.5% of 2020 revenue. However, an intrinsic value calculation assuming 1) no revenue from COVID treatment and 2) substantial revenue growth slowdown due to biosimilars of Eylea, indicates that the market is still undervaluing REGN by 60% or so. The details of this calculation are shown later in the intrinsic value estimation section.

Looking at the 5-year trends of total revenue and P/E ratio, these two have been moving in opposite directions (given below). Basically, REGN kept beating market revenue/EPS expectations, but the market did not properly adjust to the increasing revenue/EPS. You can see this "staircase down" in the P/E ratio trend when REGN reported earnings (e.g., March 2021, June 2021, etc.). I don't believe this trend will continue. The market will realize this mispricing, and REGN stock price will converge to its fair value.

Source: Graph from Seeking Alpha

Source: Graph from Seeking Alpha

Strong economic moat and great pipelines of drugs

REGN has industry-leading technology (monoclonal antibody R&D platform) and patents for commercialized drugs. Also, they have strong collaborations with other key players (most notably with Sanofi (SNY) for DUPIXENT) for the development and commercialization of drugs and treatments. These technologies, patents, and collaborative agreements provide an economic moat for REGN. Additionally, they have an impressive pipeline of drugs in development, which will positively contribute to their revenue/earnings growth in the future. A partial list of patents and drug pipeline are shown below.

Source: Table from SEC filings

Source: Slide from investor presentation

Strong Balance sheet and exceptional profitability

REGN has a very strong balance sheet. Their cash & equivalents have increased exponentially since 2012 ($230 M in 2012 to $2,072 M in 2021), and their Long-term Debt/Equity ratio (24.45%) and Debt/Assets (15.71%) are far below industry averages. Also, their profitability is top notch. All relevant metrics (EBITDA margin, Net Income margin, Return on Common Equity, etc.) show that REGN is an exceptionally profitable company that efficiently and effectively uses shareholders' money. Although the current profitability margin is inflated to 50.87% by REGEN-COV treatment, I expect it to drop back to its 5 year average of 29.36%. This is still far exceeding the industry average of -1.78% and other industry leaders such as Pfizer (PFE) (23.80%), Roche (22.58%), Gilead (GILD) (19.38%), Biogen (BIIB) (16.04%), AbbVie (ABBV) (12.40%), and Merck (MRK) (11.06%). REGN's profitability is clearly one of the best in the industry. These financial and profitability metrics are summarized below.

Source: Table from Merrill Lynch Brokerage Account

Source: Table from Seeking Alpha

Intrinsic Value Estimation

I used DCF model to estimate the intrinsic value of REGN. For the estimation, I utilized adjusted EBITDA ($3,448.6 M) excluding sales of REGEN-COV treatment as a cash flow proxy. To calculate the adjusted EBITDA, I removed the COVID treatment revenue ($2,853 M) from TTM revenue ($12,006 M), and multiplied that by the 5-year average EBITDA margin of REGN (36.63%). I utilized current WACC of 3.7% as the discount rate. For the base case, I assumed EBITDA growth of 10% (half that of REGN's 5-year average revenue growth) for the next 5 years and zero growth afterwards (zero terminal growth). For the bullish and very bullish cases, I assumed EBITDA growth of 15% and 20%, respectively, for the next 5 years and zero growth afterward. These estimations represent a conservative scenario which entirely excludes revenue from COVID treatment and also assumes substantial slowdown of revenue growth from Eylea due to competition from biosimilars.

The estimation revealed that the current stock price represents 60-140% upside. I believe the market is over-discounting REGN because of the coming reduction in revenue from COVID treatment and Eylea. Even in the complete absence of REGN COVID treatment sales in the future, the market is severely underestimating REGN's true value. I believe the market will realize and adjust for this mistake.

	Price Target	Upside
Base Case	$926.73	62%
Bullish Case	$1,139.63	100%
Very Bullish Case	$1,391.83	144%

Click to enlarge

The assumptions and data used for the price target estimation are summarized below:

• WACC: 3.7%
• EBITDA Growth Rate: 10% (Base Case), 15% (Bullish Case), 20% (Very Bullish Case)
• Adjusted EBITDA excluding COVID treatment sales: $3,448.6 M
• Current Stock Price: $570.79 (10/01/2021)
• Tax rate: 30%

Risks

It is hard to predict a timeline for changing market sentiment. Additionally, the overall market is currently experiencing a volatile patch due to uncertainties around the infrastructure bill, Federal Reserves' tapering plan, and supply chain crisis. Therefore, REGN stock will gyrate with the market for a while, and it may take some time before for the market adjustment to take place. However, I believe the market will eventually figure out the right value of REGN based on their profitability, growth trajectory (with or without COVID treatment), and strong balance sheet. The investor should be willing and able to stomach the volatility of the market and REGN stock price.

There has been increasing political pressure on controlling prescription drugs, and this may negatively impact REGN's revenue growth. However, prescription drug price involves many different entities (government entities, insurance companies, drug makers, patients, etc.), and substantial changes to existing drugs are unlikely in foreseeable future. I don't expect this possible price control to materially impact REGN's revenue, and the company should be able to manage any setbacks effectively with their strong balance sheet and pile of cash.

Conclusion

I believe REGN represents a good opportunity for investors. They are a very profitable company with a promising outlook and strong balance sheet. Currently, the market is discounting their value due to the overestimation of threats from biosimilars and the discontinuation of COVID treatment. Based on a DCF calculation that built in the assumptions that there would be no more additional COVID treatment revenue as well as a substantial decrease in revenue growth, I believe that the stock price is severely undervalued. Investors who are interested in a profitable company within the health care sector should consider REGN.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of REGN either through stock ownership, options, or other derivatives. 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.

Comments

[Cappuccino Finance]

Here is my stock chat video on Regeneron. I thought some of you would enjoy it. Have a nice weekend! https://youtu.be/rmrEyaccZz8

[Prospective_Spark]

I have been holding $REGN for years and will continue...

[dukemorty]

The REGN investment thesis may get substantially better for two primary reasons.

(1) INCREASING MANUFACTURING CAPACITY: Roche/Regeneron collaboration to significantly increase manufacturing capacity and supply by 3.5x....If my math is correct, this translates to an estimated 700k dose capacity per month --- or up to 2.1MM doses per QTR.

(2) 50% LOWER DOSE SIZE: Potential Authorization for 50% smaller dosage....e.g. from 2400mg to 1200mg. These factors set the stage for robust broad global distribution and sales of its REGN-COV2 antibody cocktail that potentially far exceed current analyst estimates.

Coupled with over $6B in Cash, and what appears to be a healthy drug pipeline and low PE....REGN is in a compelling position to generate positive returns.

[Cappuccino Finance]

@dukemorty Thank you for the insight. Certainly great news! Long REGN!!

[HiSell]

Good article, I’d prefer to use a much higher WACC of 8 to 10% as there is no debt on its balance sheet.

[Puche]

@HiSell, you may want to take another look at REGN's most recently filed balance sheet. It shows just under $2 BILLION of debt. Just thought you may want to get your facts correct.

Just my two cents. Good luck to you!

[Toucan bird]

Good analysis, thanks!

Quick question, maybe I missed it, but could you quantify how much of a slowdown of revenue growth from Eylea due to competition from biosimilars you modeled?

I know it all rolls up to your base 10% EBITDA growth projection, just curious if you put pen to paper on Dupixent growth vis-a-vis Eylea shrinkage.

[Cappuccino Finance]

@Toucan bird Thank you for reading my article. I thought it might be worth sharing my modeling philosophy for future reference as well. My response is long.

There are a quite few literature about the economy of biosimilars (www.ncbi.nlm.nih.gov/...). Based on those, these are reasonable basic assumptions you can make 1) developing biosimilars are time consuming (can take 7-8 years) and not always successful, 2) even with successful development, manufacturing and distribution are challenging, and 3) if a company achieves all these, the successful biosimilars can take up about 10% of market share (on average).

Based on those, I made the worst scenario for REGN: 1) successful biosimilars appear for whole portfolio of REGN immediately and 2) those biosimilars immediately take 10% of market share. That give me the 10% growth instead of historical 20%. One probably can argue that this is unlikely scenario, and too conservative assumption for REGN. Hope what I did is clear.

Usually, the more variables one includes in the model, the higher probability of the model to not work properly, unless the person has very accurate data/measurements for the variables. Same thing as the more parts in the machine, the higher chance of the machine to break. :)

I think there is too much uncertainty if one tries to predict the revenue of each drug for next several years. Therefore, I thought it would be better to treat the portfolio as one variable. Have a fun investing!

[Puche]

@Toucan bird just a quick fyi.....Dupixent TAM is materially larger than Eylea's TAM on a US and WW basis.

Though REGN does not record all the revenues for Dupixent and Eylea on a WW basis, way back when Dupixent was first being launched I had estimated that Dupixent's WW revenues would eventually exceed $10 BILLION. I continue to believe that pie in the sky estimate is still a possibility. Please remember that REGN does NOT record all the WW sales based on the accounting they follow.

Just my two cents. Slow and steady! Good luck to all!

[Toucan bird]

@Puche I’ll see your two cents and raise you two!

From Sanofi in July:
——
Dupixent's sales are now annualizing at €5 billion, Sibold said on the Thursday conference call. Sanofi has set a €10 billion annual sales goal for the drug, and CEO Hudson said Thursday that the drug is still “only at the beginning of its journey.”
——
With only 6% penetration in atopic dermatitis, new approved indications rolling in and patent protection into the 2030’s, $10 Billion sounds imminent. 50% of Dupixent’s US profits + 40% of its outside US profits = a ton of cash to reward shareholders today and, by investing in their pipeline for continued scientific breakthroughs, tomorrow.

Appreciate and agree with your bullish view of the stock and the management team. My entry point is much higher than yours, but I’ve set aside shares that I hope to have the discipline to hold for 10 years. If I can resist the urge to take profits I think my kids will thank me one day.

[rem12345]

A WACC of 3,7%....not hard to get such valuations then...

[strendic]

A lot of insider selling. Morningstar fair value a conservative $570. On August 18th it was reported the CEO sold 200,000 shares. How does one factor in all the insider selling this year if you are convinced in your huge upside potential? Walking away from 60% or more in additional cash on a 200K shares is huge amount of money...

[Cappuccino Finance]

@strendic I think insider trading is hard to judge, and the context matters a lot (and we never know the whole story). In Lonard Schleifer's case, he exercised 400,000 share at cost of $52.03 per share on August 09th, and he sold the half of them (200,000) on August 18th for $650.03 (total amount of $130 M). $130 M is a lot of money, but it's only about 0.2% of the market cap. Also, institutional holders increased their shares about 2.31% during the last three months, which is certainly a positive sign. I wouldn't read too much into it other than he took nice sum of money after hard work.

If you are interested in, there is the insider transaction section at the bottom of this finviz.com page. finviz.com/...
Good luck investing!

[strendic]

@Justin J. Lee Thanks on the reply. REGN has been on my watchlist and I hope to make it part my pharma portfolio if / when it reaches my target price range. Kind regards to you.

[Cappuccino Finance]

@strendic Thank you, and you are very welcome. Please feel free to share if you find great opportunities in health care or pharma (or any sector). Happy to learn more. Have a fun investing!

[Willow Point]

Eylea biosimilar competition puts ceiling on stock price.

Expect that to change as other products ramp up & Eylea carries on.

[Cappuccino Finance]

@Willow Point Yep, their impressive pipeline will bloom, and hope stock price to follow!

[BM Cashflow Detective]

The future depends on what we buy today.

I'm long $REGN

Hakuna Matata!

[Cappuccino Finance]

@BM Cashflow Detective Agree. Trying my best to make right decisions. Lion king is one of my favorite movie. Haha.

[GWith]

Not easy to buy when a stock is sinking but this feels like an opportunity to add at a very reasonable price.

Don't think the company was counting on resilient REGN-COV2 sales as part of their long-term strategy. More like a short-term phenomenon while joining the fight against the pandemic.

In addition to their established drugs,they are making real headway in oncology. Plus they have some potential moonshots out there, such as the obesity work.

Always going to be headwinds in pharma and the day to day market is impossible to predict. But today's investors will likely feel very good about their decision a year or two down the road.

[Cappuccino Finance]

@GWith I completely agree. REGN is really well run company in many different aspects, as you mentioned. Long REGN!

[Dinjax]

@Justin J. Lee good analysis. It does seem like the market overreacted to the Merck news; it's down $50/share since 10/1 which lopped off >$5.2B in market cap. Even though REGN-COV2 sales have a good chance of continuing I like your conservative approach of eliminating them for your valuation calcs. By almost any metric shares are way undervalued.

It could be a great time for another buyback program.

[Cappuccino Finance]

@Dinjax Yes, I had to re-check DCF calculation a couple of times. I thought I missed something. Hope the market realizes this gem soon. Long REGN!

[Polylog]

Rode Regeneron from 460 to 650 this summer and I'll definitely rebuild my position soon. (And I didn't sell because it reached its fair value, it was purely a trade due to the market downturn.)

[Puche]

I thought this was a very well thought out and presented article. Then again, as the SA community knows, I’v been long since before Eylea was named or approved. I expect to be a shareholder 10+ years from now.

I, too, believe REGN is miss priced stock by the Street for many of the reasons the Contributor pointed out plus additional ones that I’ve written about in the past.

REGN’s oncology pipeline is dramatically undervalued and Libtayo as a foundational oncology drug is only getting started. Furthermore, because of changes in the Sanofi’s agreement, REGN will keep a much larger portion of the revenues and profits of many of its future drugs under development.

All just my two cents. Slow and steady! Good luck to all!

[Cappuccino Finance]

@Puche Yes! Buy the right stock, and hold it forever. I think REGN really has bright future ahead. Strong pipeline, profitable, balance sheet. Thank you for all the insights you brought for pipeline and new agreement with Sanofi!

[Puche]

@Justin J. Lee thanks! The past for REGN has been pretty incredible for the past 15+ years and counting!

By the way, the strong balance sheet gives them plenty of optionality. I expect them after they get through the major lab expansion they are executing to start a multi-year expansive buyback program. If the stock stays this cheap look for a $5 billion+ multi-year program to be announced within the next 18 months or so.

My two additional cents. Slow and steady! Good luck again to you!

[Cappuccino Finance]

@Puche Seems like you know a lot about REGN. This is one of my main reasons to publish articles on Seeking Alpha. Learning new aspect every time. Thank you! Slow and Steady, indeed!

[Prospective_Spark]

It’s time for REGN to split now.

[Cappuccino Finance]

@Prospective_Spark I think that would be nice. It will certainly make the stock more affordable/attractive. Long REGN!

[Puche]

@Justin J. Lee IMO a stock split is not likely as Leonard would prefer to have large long term institutional investors and employees rather than the more volatile retail investor. My two cents.

Slow and steady! Good luck to all!

[Dinjax]

@Prospective_Spark while not an academic study, this research shows that splits generally don't increase share prices, except for companies with low/sell analyst ratings.

www.schaeffersresearch.com/...

Other studies have found similar results.

REGN has 14 buy, 2 overweight and 9 hold ratings with nothing lower than hold so its analyst rating is relatively high.

[ray69]

Good conservative valuation.
What the market does in the short term - unknowable!

[Cappuccino Finance]

@ray69 Thank you! Long REGN!