Leon Cooperman’s Diamond in the Rough

By Ryan Guenette - July 24, 2012 | Tickers: ACT, MYL, PRX, TEVA | 0 Comments

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Yesterday at the Delivering Alpha Conference Leon Cooperman presented on the “best ideas” panel his top stock picks for 2012. When asked to present his one best idea for 2012, Leon Cooperman said he could not distinguish between his top picks because choosing one was like picking between his children. Leon Cooperman, The Omega Advisors CEO, was able to distinctly say that putting money in treasuries is a waste of time and money, comparing purchasing treasury bonds to, “walking in front of a steamroller to pick up a penny.” Leon Cooperman then went on to discuss and explain each and every one of his ten picks.

Leon Cooperman’s picks ranged from the Gannett Company to the Halliburton Company, but all had one trait in common, according to Leon Cooperman, extreme value. All the companies had price to earnings ratio in the single digits or in the tens area, then I stumbled upon Watson Pharmaceuticals (NYSE: ACT). Having a price to earnings ratio of 36.35, value play was the last thing that came to my head, but then I thought about why Leon Cooperman called it a value play, and wondered, had Cooperman found a diamond in the rough?

Incredible Growth

In 2010, Watson Pharmaceuticals reported earnings per share of $1.48. In 2011, Watson reported earnings per share of $2.06. This jump in earnings per share displays a 39.19% year over year growth rate. In 2012, the average consensus believes earnings per share will reach $3.49. Again this shows an incredible 69.42% year over year earnings per share growth rate. This extraordinary growth will continue into 2013 as the average consensus believes Watson’s earnings per share will grow to $5.76, presenting a 65.04% growth rate. In 2013, earnings per share are anticipated to climb to $8.30. This reaffirms Watson’s ridiculous year over year growth rate trend, reaching 44.10%. Watson, at the moment, has approximately 160 generic pharmaceutical product families and approximately 30 brand pharmaceutical product families in the United States, and has a market capitalization of 9.87 billion. Watson Pharmaceuticals is not a microscopic pharmaceutical that only possesses one or two drugs. If something happened to ten of Watson’s drugs, they should survive, and be able to thrive in the future. Watson’s distinct growth is displayed in the chart below, showing Watson’s sales, operating profit, net income, net margin, and operating margin, and earnings per share over the coming years. 

Watson is Worth Every Penny

Watson Pharmaceuticals has a price to earnings ratio of 36.35 at the current price of $77.46. The S&P 500 average price to earnings ratio is sitting around 15. Although Watson Pharmaceutical’s may appear to be overpriced on the surface, the price to earnings ratio does not take into account Watson’s explosive growth. The price to earnings to growth ratio does take into account Watson’s growth. A price to earnings to growth ratio is fairly priced when it is at 1. Watson Pharmaceutical’s price to earnings to growth ratio is 0.86, stating that Watson is underpriced when growth is taken into account. Additionally, because of Watson’s growing earnings per share, the price to earnings ratio will decrease over time if the stock price holds its current level. By the end of 2012, the price to earnings ratio is expected to drop to 22.2. In 2013, the price to earnings ratio is anticipated to fall below the S&P 500 average, hitting 13.5. The projected price to earnings ratios are contingent on the fact that the stock price remains at $77.46, which I doubt will happen, as market fluctuations occur every day. All in all, Watson Pharmaceuticals may appear to be, at the moment, trading at a premium, but has incredible growth that justifies Watson’s high price to earnings ratio. The below chart predicts Watson’s price to earnings ratios if Watson’s stock price remains at $77.46. 

Is Watson Pharmaceuticals the King?

Compared to some of Watson Pharmaceutical’s main competitors such as: Mylan Inc. (NASDAQ: MYL), Par Pharmaceutical Companies Inc. (NYSE: PRX), and Teva Pharmaceutical Industries Limited (NYSE: TEVA), Watson Pharmaceuticals excels in the majority of the categories.

Earnings per Share Comparison

Earnings per share analysis will allow the investor to see the underlying business’s growth fundamentals, and growth consistency.  

Based on $1 Starting Point

Watson Pharmaceuticals is the fastest growing company in the sector, turning $1.00 of earnings per share in 2010 into nearly $6.00 in 2014. Additionally, Watson has the most consistent growth in the sector, increasing at nearly the same rate every year. Watson is a highly diversified pharmaceutical with over one hundred generic drug families, but is growing at a pace that outshines all of its competitors. Mylan is second in the sector, growing at an admirable rate, while Teva and Par both grow at a rather sluggish pace. Watson’s hyper growth will allow Watson to reinvest in its business and acquire other companies that can offer more accelerated growth.

Price Value to Book Value Ratio Comparison

The price to book value ratio comparison will enable the investor to determine how much book value is priced into each share and determine how much he/she is paying for future growth.

Watson Pharmaceuticals has the second lowest price to book ratio in the industry, meaning investors in Watson will not have to pay as much for future growth as in other names. Teva has the lowest price to book ratio in the industry because Teva has less growth to offer in the future. Mylan and Par are both very similar to Watson as they have quickly declining rates, signaling over the years more and more book value will be produced in the companies.

The Foolish Bottom Line

Watson Pharmaceutical does not pay out a dividend. In this volatile market, a dividend is a very reassuring characteristic in a stock. The cold hard truth is that the pharmaceutical industry is extremely risky, as one day a drug could be the only one on the market, and the next day a generic drug could ruin the original’s pricing power. To counter this risk, Watson Pharmaceutical is highly diversified, having nearly two hundred total drugs, and is growing at an absurd growth rate. Leon Cooperman may have been on to something when he recommended Watson Pharmaceuticals.      

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