Hedge Fund Brahman Capital Bets Big on This Pharma Stock

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A 13G filed with the SEC has disclosed that Brahman Capital, a hedge fund managed by Peter Hochfelder and his team, owns 6.3 million shares of Endo Health Solutions (NASDAQ: ENDP), a $4.3 billion market cap pharmaceutical company.

We track quarterly 13F filings from hedge funds such as Brahman as part of our work researching investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year) and so, we can see that this position is more than double the 2.7 million shares that the fund had owned at the end of March; Brahman had only started buying shares earlier this year. See more of Brahman's stock picks from the end of Q1. The fund’s stake in Endo has grown to 5.7%.

In Endo’s most recent 10-Q, the company reported a small increase in revenue compared to the first quarter of 2012. However, a number of costs -- including R&D expenses -- were cut over this time frame and so, if we exclude special items such as litigation and asset impairment charges, we get operating income of more than $140 million as opposed to an operating loss in last year’s Q1. Even including these special items as charges, Endo turned a profit during the quarter. We would note, however, that a large increase in working capital caused cash flow from operations to be negative.

Analysts expect adjusted earnings per share to be $4.32 for this year, making for a current-year P/E multiple of 9. While that seems low, the sell-side (which for many companies is often accused of being too optimistic) expects EPS to decline considerably in 2014. Their projections make for a forward earnings multiple of 10, and for the stock to be a value play it would likely have to keep its business constant from that point forward. In May, we had noticed Tiger Cub John Griffin’s Blue Ridge Capital reporting a position of 6.6 million shares in Endo itself, giving that hedge fund close to 6% ownership as well (find Griffin's favorite stocks). 12% of the float is held short.

Other pharmaceutical companies include Abbott Laboratories (NYSE: ABT), Pfizer, Gilead Sciences (NASDAQ: GILD), and Teva Pharmaceutical (NYSE: TEVA). Of these four names, Pfizer and Teva have the lowest forward earnings multiples -- specifically, they trade at 12 and 7 times respective forward earnings estimates. These two stocks also stand out from the two other peers -- as well as Endo itself -- in featuring dividend yields of about 3% (and higher in the case of Pfizer). We’d note, however, that both Pfizer and Teva Pharmaceutical experienced a decline in revenue in the first quarter of 2013 versus a year earlier and in Teva’s case, this contributed to a 27% fall in earnings.

Abbott and Gilead, meanwhile, at least managed to increase their sales in their most recent quarter compared to the same period in their previous year, though Abbott seems to have had trouble with its margins leading to a drop in net income. The sell-side is expecting Abbott to continue to struggle: its trailing P/E of 11 and forward P/E of 16 show that analyst consensus is for a decline in earnings per share over the next year and a half, after which the market would be pricing in a recovery in EPS that we might not want to count on. Gilead has more than doubled in price over the last year, placing it at a premium to its peers at a valuation of 18 times consensus earnings for 2014, but it has managed to improve on both top and bottom lines.

As a result, Gilead might be worth looking into as a growth stock, although the current pricing does already include quite a bit of expected increases in EPS next year. Endo Health, and some of the other companies we’ve covered here, are closer to the value end of the spectrum though business conditions are not expected to be that good over the next several years. While Brahman, Blue Ridge, and others are banking on the decrease in earnings being less than what analysts expect, there is also significant short interest and so, we would not be too excited about the stock.

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This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article.The Motley Fool recommends Gilead Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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