Transitioning from a niche drug maker into a "Big Pharma player"
can be fraught with challenges. As these companies seek to grow
through the development oracquisition of new drugs, they need to
keep an eye on their existing portfolios of products as well. New
competition from rivals can blunt the sales of current drugs and
medical products, even as new ones are entering the mix.
That was the hard lesson learned by Ireland's
Warner-Chilcott (Nasdaq:
WCRX
)
, which saw itsshares slump badly in the summer of 2011. Management
eventually sought to goose the stock with some bold moves, but
those efforts also failed, and shares now trade well off of their
highs.
With no tricks left in the bag, management must focus on
rebuilding a challenged business. The good news: Warner-Chilcott's
shares nowoffer deep value compared to other drug makers.
Slowing sales and antsy investors
Warner-Chilcott's quarterly sales peaked in the second quarter of
2010, and have been pressured ever since. The company had a series
of leading products in women's health care, such as
gastroenterology, urology and dermatology. Yet rival products have
hit themarket and have eaten away at some of Warner Chilcott's
strongmarket share in various categories. The company's Actonel
drug, which helps sufferers of osteoporosis, has been a notable
market share loser in recent quarters. Doryx, an acne drug, has
decreased in sales after it lost patent protection, which opens the
door for competition to release cheaper, generic versions. The drug
pulled in $30 million in global sales for the quarter ended March
31, 2011, down 55% from the year-ago period.
Slowing quarterly sales ($ millions)
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By the summer of 2011, investors gradually came to see that
sales growth was unlikely to rebound any time soon, so they began
to flee this stock. Warner-Chilcott finished the year near
multi-year lows, as you can see in the chart below.
.png)
By early 2012, management realized sales challenges were pretty
stiff, and that it might just be easier to find a buyer for the
whole company than to try to overcome those hurdles. Investment
bankers put out feelers and apparently received solid interest,
which led to the announcement in late April that an acquisition
might take place. Shares quickly spiked near $20, but in the
ensuing months, it became apparent that no white knight would
emerge, sending shares right down to $13, where they roughly stand
today.
Abuyout had been a clearly-stated goal of the company's key
backers, which included Thomas H. Lee Partners LP, Bain Capital LLC
and the buyout unit of
JPMorgan Chase & Co. (NYSE:
JPM
)
. They were actually able to take Warner Chilcott private in 2005
and brought it public again in 2006. But just a few weeks ago, the
financial entities decided they'd had enough, and announced plans
to sell their collective 42 million-share stake in a secondary
stockoffering .
I think they could be making a big mistake.
That's because Warner-Chilcott, despite its top-line challenges,
is remarkably profitable. It routinely generates more than $3
infree cash flow per share , which works out to be a 25%free cash
flow yield at current prices. That's about the highest free cash
flow yield you will ever see for a stock that is not on the cusp of
a sharp drop in free cash flow.
Goldman Sachs foresees free cash flow per share rising 9% next
year to $3.58, but even this forecast could prove to be
conservative as Warner-Chilcott intends to buy back up to $250
million in stock by the end of this year. A smaller denominator
means higher per-share free cash flow.
Analysts at UBS consider this stock to be a deep bargain, as
seen by their $24 target price (nearly 90% above current levels).
They hosted investor meetings with management this week and were
surprised to hear that management expects 2013earnings per share to
be a bit higher than this year's. So while consensus forecasts
anticipate a drop of 4% in earnings to $3.53 per share next year,
UBS management suggests earnings of roughly $3.75 per
share.
"Management pointed to a good chance thatmultiple new products
could get approved over the next six to nine months that should
help protect key franchises (OCs/GI) and this should boost investor
confidence in the sustainability of the business," they wrote in a
Sept.18 note to clients.
Risks to Consider:
Investors have been burned by this stock repeatedly, so they
may wait and see if management actually delivers on the rising 2013
earnings per share they've suggested.
Action to Take -->
Warner-Chilcott is far from the most dynamic operator in the Big
Pharma space, but it may well be the cheapest -- by a
considerablemargin . For those who look for investments throwing
off verifiably robust free cash flow, then this stock should have a
place on your research list.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.