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:
- The market is overestimating the impact that lower REGEN-COV treatment and Eylea sales will have on future revenue.
- REGN has strong economic moat protected by its technology and patents.
- 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.
Very Bullish Case
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%
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.
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.