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 or acquisition 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 its shares 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 now offer 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 the market and have eaten away at some of Warner Chilcott's strong market 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)
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.
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.
A buyout 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 stock offering.
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 in free 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 2013 earnings 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 that multiple 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 considerable margin. For those who look for investments throwing off verifiably robust free cash flow, then this stock should have a place on your research list.