PropThink: ENDP's Deep Discount Won't Last; Upside Scenarios Are Icing On The Cake
(Thomson Reuters ONE) -
By David Moskowitz
Shares of Endo Pharmaceuticals (NASDAQ:ENDP) are trading at a deep discount to
other pharmaceutical companies, with the last dip in price coming on the heels
of guidance at the company's recent Analyst Day (see our prior story). Based on
the company's outlook, 2013 revenues are expected to be in the range of $3.0-
3.2 billion, with EPS ranging from $5.20-5.40. While the high end of revenue
guidance just graced Wall Street's $3.2B average estimate, EPS guidance came in
lower than the $5.51 Consensus forecast. As a result, shares of ENDP fell after
the meeting had ended and continued to slide to the $29 range. So why is lowered
guidance bullish for the stock? The answer: the resolution of the "earnings
cliff" and ENDP's very low P/E multiple. The earnings cliff and how to invest
based on this common phenomenon in the drug industry is explained below. A key
to the investment thesis is that despite the anticipated 2013 launch of a
generic version of Lidoderm, ENDP's largest product, the company's agreement
with generic drug company Watson Pharmaceuticals (NYSE:WPI) has smoothed out the
impact of declining contributions from this important earnings component. On
both near- and long-term earnings, ENDP is now too cheap to ignore, and
investors are starting to recognize that the heavy discount on future earnings
presents a buying opportunity.
Buying Drug Stocks After The "Earnings Cliff" Has Been A Winning Strategy.
Lidoderm is a topical patch that delivers the anesthetic agent lidocaine to the
skin to alleviate pain. The drug is expected to achieve peak sales of
approximately $950 million this year, but will begin to decline next year on the
entry of generic competition. The ENDP story is far from the first time that
investors have dealt with drug companies losing major products to generic
competition. Note that P/E multiples for major drug companies fell to around 7x
forward earnings, when firms like Pfizer (NYSE:PFE), Eli-Lilly (NYSE:LLY), and
Sanofi Aventis (NYSE:SNY) were set to lose their biggest earnings drivers;
Lipitor, Zyprexa, and Plavix, respectively, to generics. What's key, is that
once these companies were within a year of generic entrants and earnings
estimates reflected their approaching earnings trough, P/E multiples for these
stocks were able to expand, as the uncertainty around long-term earnings had
been lifted. In fact, major pharmaceutical companies now trade, on average, at
11.3x forward earnings (see above), despite the continued lackluster outlook for
the industry.
Lidoderm Settlement A Great Move By ENDP; Upside Potential Exists. The
opportunity to own ENDP is similar to big pharma companies after earnings cliffs
were fully modeled and valuations overcorrected in front of trough earnings.
Note that both PFE and MRK each have climbed 45% from trough to peak in the last
52 weeks, despite major earnings drivers Lipitor and Singulair losing patent
exclusivity this year. With WPI preparing to launch its generic Lidoderm in
September 2013, and the company's Analyst Day clarifying earnings after this
event, now is the time to get involved in ENDP. Moreover, unlike big pharma
companies, which lost most of the economics to generic versions of their top
products, ENDP was smart enough to enter into a legal settlement with WPI when
Lidoderm's patents were being challenged in court. Based on the settlement, WPI
cannot launch its generic Lidoderm until next September, and ENDP is entitled to
receive 25% of gross profits from WPI's generic Lidoderm. Note that the terms
of this settlement are not applicable if another generic comes to the market,
and if that occurs, ENDP would likely launch its own generic. Nevertheless, thus
far no other generic has received FDA approval. Mylan Inc. (NYSE: MYL) is
thought to be the closest to market, but past generic Lidoderm candidates,
specifically those using the technology in MYL's formulation (an acrylic
formulation), have been unsuccessful in replicating the Lidoderm brand to FDA
specifications. In fact, WPI was using this same technology when it finally
abandoned the project and switched to using the same formulation approach as the
original Lidoderm brand (hydrogel technology), hence the patent challenge by WPI
and subsequent settlement with ENDP.
ENDP has its own generic division, called Qualitest, and it is likely that the
managers of this business unit were instrumental in ENDP's proactive approach by
getting in front of the generic Lidoderm threat, settling it, and bringing it in
for a soft landing. Assuming there is only one generic version (WPI's) on the
market for several years, the discount to brand is likely to be relatively
small, and this could enable ENDP's brand to keep a larger-than-usual share of
the market. Typically, generic entrants will penetrate up to 90% of the brand
market on a volume basis within 6-9 months of launch, and with multiple generics
on the market, price will usually fall by 85-95%. This recently happened with
generics to Merck's Singulair product, which has been decimated by the new cheap
competition. However, under a scenario where a sole generic Lidoderm comes in at
roughly a 15%-20% discount, not only will pricing remain robust, but the actual
brand product could retain 25-30% of the market in terms of unit volume. As long
as no new generic gets approved, this scenario would likely be sustainable, with
WPI benefitting from a large and profitable generic product, and ENDP holding on
to way more of the market than typically seen, plus the 25% share of profits on
WPI's generic. Based on guidance from ENDP, the additional upside to earnings if
only WPI's generic comes to the market calculates to about $0.60 per share, and
notably, Wall St. Consensus expectations are already discounting in Mylan
entering the market in 2014. Analyst's average EPS estimate for ENDP in 2014 is
$4.72, suggesting that if MYL doesn't get to the market, there is approximately
12% upside to earnings expectations on the single generic Lidoderm thesis. Note
that even if MYL does get to market, shares of ENDP remain cheap on earnings
under that scenario. Either way, investors win.
Opana ER Growth Acceleration Will Move ENDP Higher. Opana ER is ENDP's extended
release formulation of oxymorphone, a highly potent pain medication and a key
driver of the company's future growth. The drug is indicated for the relief of
moderate to severe pain in patients requiring around-the-clock opioid treatment
for an extended period of time. After the company launched Opana ER and took
sales up to $384 million/yr. and growing, manufacturing partner Novartis
(NYSE:NVS) experienced supply issues, short-circuiting the product's growth
trajectory. In addition, ENDP reformulated Opana ER as an abuse resistant
product, and in June the company removed the old Opana ER formulation from the
market. Notably, the FDA added the former Opana ER formulation to its
discontinued products list. The reformulated product required some doctor
education regarding the new formulation's benefits and "sameness" in terms of
efficacy to the old formulation. Doctors question reformulated pain medications
on skepticism that they may not work as well as the original product, worrying
that patients could complain. However, this is not the case with the new Opana
ER formulation; efficacy between the old and new product is exactly the same.
After the supply disruption and switch to the abuse-resistant formulation
earlier this year, total prescriptions for Opana ER declined and the mix of
prescriptions has trended toward lower strengths of the product (which carry a
lower price). The new Opana ER is has an annual run-rate of about $320 million,
and because of the recent 'flat' prescription trends, analysts have lowered
their revenue and growth expectations for the drug. The company expects
prescription trends for Opana ER to stabilize by the end of the year, with a
return to growth in 2013. As a result, re-acceleration of Opana ER prescription
trends will send shares of ENDP higher.
Despite discontinuation of the old Opana ER formulation, there is potential for
a generic version of this product to come to the market in January 2013, which
is also weighing on analyst's expectations and enthusiasm for the stock.
However, the company has already shifted 90% of sales to the new abuse-resistant
form. Importantly, a generic for the old Opana ER won't be directly
substitutable (AB rated by the FDA) for the new formulation, therefore, brand
sales are not really at risk. In order for the generic to be dispensed, assuming
the FDA approves it, doctors would have to write a prescription specifically for
the generic of the old formulation. Because the old formulation was removed by
ENDP for safety reasons (high abuse potential), the FDA may in fact, be
reluctant to approve a generic for the old formulation, and no FDA approval for
the generic would be good news for ENDP as all doubt about Opana ER as an
exclusive brand would be removed. ENDP still expects long-term peak sales for
Opana ER at $800 million annually, given the new formulation's patent life out
to 2029, but because of the slower sales ramp and perceived generic threat,
analysts are modeling Opana ER conservatively. As a result, a pickup in
prescription trends for Opana ER and/or the FDA deciding that no generic Opana
ER (old formulation) will be approved, are both events that will drive ENDP
shares sharply higher. Even if a generic for the old Opana ER is approved, the
impact to the new formulation is likely to be minimal. We've seen this kind of
situation before when Teva Pharmaceuticals (NASDAQ:TEVA) received FDA approval
for generic TriCor (Abbott's triglyceride reducing medicine), however, Abbott
(NYSE:ABT) had converted all of its sales to new a TriCor line with different
dosage strengths. Unfortunately for TEVA, there was almost no substitution to
its generic version because it was not directly substitutable to the new TriCor
line and doctors had stopped writing for the old strengths. A decision by the
FDA on whether or not a generic for the old Opana ER formulation is approvable
is expected in the next couple of months, a key catalyst for ENDP.
Strong Cash Flow Supported By Diversified Lines of Business, Pipeline Is Largely
Free. Other components of the story center around: 1) ENDP's generics business,
Qualitest, which continues to grow at double digit rates and is expected to have
stable-to-expanding gross margins on niche generic products; 2) The company's
American Medical Systems division, a device and services business, focused on
Urology and Women's Health and growing on an accelerated basis with expanding
margins; and 3) ENDP's drug pipeline which is getting virtually no credit from
the market and features products like Aveed (testosterone injection, resolution
of FDA complete response letter issues expected next month), BEMA Buprenorphine
(novel pain drug, Phase III results expected in 4Q 2013), and Urocidin (bladder
cancer treatment in Phase III). For reference, the Qualitest division is
expected to represent about 21% of sales this year; American Medical Systems
(plus the Healthtronics business) is expected to contribute 24% of 2012's sales
base; with ENDP's brand drug products comprising the remaining 55% of revenues.
With no new business or product acquisitions, Endo's brand drug sales are
expected to represent just over 40% of sales by 2014, with the other two
business segments growing to fill the Lidoderm erosion gap.
Important for value investors, ENDP offers significant cash flow, with a current
cash flow yield (free cash flow/ enterprise value) of approximately 10%.
Management expects to shrink annual operating expenses by $150M between now and
2015 by reducing promotional resources behind Lidoderm and other cost
containment initiatives. This should help keep earnings relatively steady over
the period when Lidoderm brand sales fade away. With its excess cash, ENDP
continues to pay down debt and buy back stock, thereby positioning the company
to drive more leverage to the bottom line. Click here to continue reading.
See "ENDP's Deep Discount Won't Last; Upside Scenarios Are Icing On The Cake" in
its Original Form.
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Datum: 02.11.2012 - 15:15 Uhr
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