Mylan Transitioning from Generics
Board: Value Hounds
Mylan isn’t a bad generics company. Generic pharmaceuticals is a tough business with low margins a rabid competition. What makes Mylan mildly interesting are the recent acquisitions and transition of the business from the overcrowded low margin generic generics business to a more specialized pharmaceutical company.
Mylan does have a few tics I found annoying:
• There is no table of top sellers and while that’s sometimes understandable with generics since companies can have hundreds (Mylan has 1300 products) of them all selling at uninteresting levels, Mylan has branded generics and I’d like to hear how those are doing.
• Management insists on using non-GAAP earnings both for reporting quarters/annual and for guidance. After looking through what they adjust out, it’s not a good way for a potential investor to evaluate their returns.
• Lack of a brand name blockbuster.
• Specialty and generic segments are not reported separately allowing us to know the margins for each.
Generics is a hard way to make a living. Gains from new launches can drop precipitously as the six-month exclusivity expires and the drug is thrown into the broad generic sea available to anyone that has the facilities to make it. For instance in 2013 four drugs that did $784 million in 2012 dropped to sales of $198 million in 2013. This timing issue of great launches and rapid expirations makes year to year increase in revenue difficult to predict and highly variable. A strong brand under patent preferably a blockbuster (like Teva’s Copaxone) insulates a company from the impact of generic variability. Mylan has no real billion dollar blockbusters at present, but expects their EpiPen for anaphylactic shock will hit $1 billion in sales in the next year. It will be their first real blockbuster.
Medications contribute most significantly to revenues and gross margins at the time of their launch and even more so during periods of market exclusivity with limited generic competition that usually last six months. As such, the timing of new product introductions can have a huge impact on Mylan’s financial results. Delays in approval are common and never a positive for earnings or the share price.
The Mylan specialty segment (injectable medications) are a wider moat, higher margin and higher growth segment. It was not a large percentage of revenue and sales were largely due to the EpiPen. With the acquisition of Agila, Mylan has taken a step towards expanding specialty and it’s now 14% of revenue. They expect specialty to hit $2 billion in sales by 2018.
Non-GAAP EPS and PE
During the conference call, they discussed non-GAAP EPS ie adjusted only and never mentioned GAAP earnings. When we buy a company and pay a price based on PE, it’s the GAAP earnings that count and by that measure, Mylan is a shade on the high side at a PE of 32. They do have to report GAAP EPS in filings. In Q1, GAAP EPS was 29¢ and non-GAAP EPS was 66¢ and it’s easy to see why they want the market and analysts to hear the non-GAAP numbers repeatedly.
Mylan guidance for 2014 is $8 billion in revenue (midrange). At the recent Q’s 7% margin, that would work out to a 2014 EPS of $1.42 The non-GAAP EPS guidance is $3.25-$3.60. The “gap” is huge between the two. Abbvie’s generic segment sale to Mylan will be consummated in 2015 and add about $2 billion to revenue. Going out on a limb and making some guesses about revenue and margins, the forward forward PE for 2015 would be around 25x.
Some expenses are distorting and can be eliminated. This is what Mylan takes out:
• Litigation settlements
• Interest expense
• Non-cash adjustments for contingent consideration liability
• Clean energy investment pretax loss
• Acquisition costs
While some of these are one-time and non-cash and don’t impact cash earnings, others should be left in. Acquisitions are real costs and recur with some frequency; clean energy investments were for a tax break and should count; restructuring is a way of life and a real cost it counts; ditto litigation although sometimes they reap and sometimes it is a cash outflow but it counts; interest expense definitely. That leaves one or two small accounts that are non-cash and wouldn’t move the needle much. My inclination is to go with GAAP and try to value Mylan by something other than PE (which I look at but don’t like as a valuation measure).
Non-GAAP EPS makes the company look cheaper. Using non-GAAP 2014 guidance of EPS of $3.60, the PE is 14x. It’s difficult to know how the market sees it. Does the market like the non-GAAP story and think Mylan is cheap? Or should we be listening to the GAAP story? A few more valuation measures may help.
Valuing Mylan with a discounted cash flow shows it to be fairly valued to slightly undervalued. Mylan’s guidance for growth is 13% through 2018 and with that as the 5-year growth rate declining to 3% by year ten gives a value of $57. Like most drug companies, Mylan has solid cash flow from operations that has increased every year in the last eight except for 2011. Free cash flow is positive in years where acquisitions aren’t made.
[See Post for Tables]
Acquisitions are returning value. The 2013 ROIC is 10.5% and the WACC is 8%. Mylan is just slightly undervalued at current prices and is returning value to shareholders. Price appreciation has outpaced the S&P by a wide margin.
The business is low margin with not entirely smooth predictable growth making it hard to justify buying near historic highs. Mylan trades at $51 just 10% off its all-time high of $57. The AbbVie acquisition will add around $2 billion in revenue in 2015 and if we get more information on the products included and the margins (should be higher than generic margins) Mylan could be investment-worthy with this known catalyst coming on board. As it sits even without AbbVie there are interesting products in the pipeline and some potential blockbusters that are waiting for submission and approval and represent additional catalysts. Unlike the AbbVie portfolio, there is an element of risk as these expected approvals could be delayed. Copaxone is the most important and analysts are keyed in on every move Mylan makes to get Copaxone to market this year. If that doesn’t happen, share price will drop. Blockbusters include Advair ($4.7 B), Seretide (combined $2.2B), Copaxone ($3.5B), and Lantus ($6B). These are one to several years out and as always, final say is with the FDA.Things that might make me invest
• Injectables were $300 million in revenue in 2013. Mylan projects that will increase to $600 million with the Agila acquisition in 2014. While we can’t put a number on injectable margins, Mylan, in their investor presentation, says they are higher growth and higher margin. Agila will double the injectable business and should expand operating margins. They predict injectables will reach $2 billion in revenue by 2018 up from $300 million in 2013. Higher margins that are expanding over years would make Mylan more attractive as an investment
• They are building expertise in biologics with one Phase 3 product in clinical trials and blockbusters like Humira and Enbrel in the pipeline. They have a dedicated biologics R&D facility.
• Global business is improving the tax rate yearly and the AbbVie acquisition will make further improvements in the tax rate and free up locked up cash stuck overseas.
• Lower priceSome negatives include:
• Dilution from the AbbVie acquisition
• Relatively high debt with debt/capital at 73%
• Low margins and intense competition
There are reasons to keep Mylan on a watch list or even buy a small initial position. As it diversifies away from its biggest percentage of business in vanilla-flavored generics, it will become less sensitive to winning 6-month exclusives and the huge loss of revenue that follows when the six months is up. Biologics and injectables are better suited to longer lives with less competition. Margins should improve.
Mylan has a huge number of ANDAs in the works both from their own organic pipeline and from the Agila acquisition. While most of these are basic generic low margin medications, they are transitioning to a business capable of production in branded generics, injectables and biologics. The more complex medications will see less competition and provide a better moat and more predictable revenue growth and cash flow.