2 pharmaceutical stocks trading below their book value
You know when a company is in big trouble when its shares are trading below its book value, defined as the total value of its assets minus all outstanding liabilities. More often than not, these stock classes represent significant buying opportunities, because even the smallest of good news can reverse their woe.
Famous value investor Seth Klarman once said, “We define value investing as buying dollars for 50 cents. Today, let’s take a look at two pharmaceutical stocks that can bring wealth to value-driven investors.
World’s leading manufacturer of generic drugs
With a market cap of $ 13.47 billion versus $ 14.588 billion in equity, investors may be wondering why the world’s largest generic drug maker, Pharmaceutical industries Teva (NYSE: TEVA), is currently trading below its book value. There are three reasons for this.
First, the Food and Drug Administration is breaking new records in terms of generic drug approvals. In 2019, the agency approved 1,171 drugs, a historic record. The more imitation drugs there are on the market, the harder it is for generic manufacturers to achieve better margins due to competition.
Second, Teva is being sued by counties, cities and states nationwide for its role in the manufacture of prescription opioids that contributed to the opioid crisis. Last year, the company offered a $ 23 billion settlement in the form of donated naloxone, which is estimated to be manufactured at around $ 5 billion. However, not all states agree with the idea.
Finally, the company, along with other pharmaceutical peers, is accused of violating the Sherman Antitrust Act by simultaneously raising the price of generic drugs by more than 1,000% since the start of 2010.
While the company faces many headwinds, the fact that investors insist the stock should trade below its net assets should indicate that some concerns are being exaggerated.
For starters, the company’s revenue grew 5% year-over-year in the first quarter of 2020 to $ 4.357 billion. In addition, the North American segments represent only less than half of Teva’s overall revenue. Its operating segments in the rest of the world are not expected to be significantly affected by the new FDA initiative.
Next, there haven’t been many material updates regarding opioid-related litigation since the company announced a proposed settlement, possibly due to the disruption caused by the coronavirus pandemic. The number of opioid overdose-related deaths in America has declined in recent months.
Perhaps more importantly, Sanofi (NASDAQ: SNY) recently settled its share of the generic pricing lawsuits in March, paying just $ 195 million. This is a tiny fraction of the sales generated by any large-cap pharmaceutical company and sets a good precedent for Teva.
Two Teva initiatives, Austedo for the treatment of tardive dyskinesia and Ajovy for the treatment of migraine, are expected to bring in at least $ 900 million in revenue this year. Currently, Teva is trading below seven times its mid-year 2020 free cash flow target of $ 2 billion. Combined with the fact that it is trading below its net assets, it may very well be a stock that has the potential to enrich pharmaceutical investors.
The most controversial name in pharma
With a market capitalization of $ 280 million, but net assets of $ 1,895.8 billion, Mallinckrodt (NYSE: MNK) is arguably the biggest anomaly in the healthcare industry. The company’s market cap is so low that it is currently trading below its cash balance of $ 808 million and 12-month free cash flow of $ 519 million. Which give?
The vast majority of the company’s revenue comes from HP Acthar Gel. This anti-seizure drug is approved by the FDA for 19 conditions, including infantile spasms. The price of Acthar was increased almost 100,000% to $ 38,892 in 2019, from $ 40 in 2001, simply because there was no law against price hikes in the United States.
Fortunately, government agencies have caught the Mallinckrodt gimmick. This year, the Department of Justice announced that it is suing the company for alleged unauthorized Medicare rebates and that it could face hefty cancellation fees if convicted. Nonetheless, the drug still generated $ 167.6 million in revenue in the first quarter, albeit down 25% from the previous year.
If that weren’t enough, two more drugs manufactured by Mallinckrodt are expected to lose their market exclusivity this year, putting around $ 464 million in revenue at risk from generic competition. The news couldn’t have come at a worse time, as Mallinckrodt also has $ 7 billion in debt and litigation settlements for his role in the opioid crisis.
However, there is light at the end of the tunnel. Currently, Mallinckrodt is still profitable on the basis of free cash flow and its shares could be obtained at a low price. In addition, the company is also submitting its biological license application to the FDA to market regenerative artificial skin for severe burn patients.
Ultimately, whether or not to invest in Mallinckrodt comes down to a matter of taste. Cautious investors who aren’t comfortable with high-risk stocks may want to stay away. However, for other investors only interested in making money (i.e. disregarding the ethics of rising drug prices), there is ample money to be made in this struggling stock.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.