Will These Situations Make This Value Stock Pop?

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Warner Chilcott (NASDAQ: WCRX) is a specialty pharmaceutical company based in Dublin, Ireland.  Two positive news items came out for WCRX recently.  It is in the mix to acquire Endo Health Solutions (NASDAQ: ENDP), and it recently announced FDA approval of a product that should extend the lifespan of its most important drug franchise.  Also, the shares appear relatively inexpensive.

Warner Chilcott’s products focus on women’s healthcare, gastroenterology, dermatology, and urology in North America and Europe.  In the most recent quarter, the firm reported flat sales except for their drug ASACOL, used for the treatment of ulcerative colitis.  ASACOL, a form of mesalamine, is the driver of growth for the firm.  With its patent expiring in July 2013, there was concern of a generic substitute despite the high barriers to entry set by the FDA.

Pennsylvania based Endo Health Solutions provides specialty products for pain management, urology, endocrinology, and other areas of healthcare.  In the trailing twelve months, Endo has been profitable making $12.5 million on $3 billion in sales.  The company carries a large debt load of over $3 billion which makes the D/E to a frightening 165.  Certainly with a takeover by WCRX, the company's capital structure will no longer be a problem.

Delzicol Approved by FDA, Generic Threat Pushed Back

WCRX shares sold off following comments made at the Actavis analyst meeting in late January.  Management of Actavis stated it was possible to make a generic form of mesalamine (ASACOL) although there are high barriers to selling the drug set by the FDA.  The Street has had ongoing concern of generic competition to WCRX’s mesalamine product ASACOL.

WCRX helped dispel concerns with the announcement on Feb. 5, 2013 that the FDA approved DELZICOL, a 400mg delayed release mesalamine product used for the treatment of ulcerative colitis, pushes that concern back. Warner Chilcott’s current mesalamine product is ASACOL and it’s one of the firm’s most valuable franchises.  The difference with the new product is DELZICOL is a capsule where ASACOL was a tablet.  It is protected by the same patents through July 2013 but there is the expectation that additional patents will be issued resulting from the change.   The approval pushes back concerns of generic competition by 2-3 years according to analysts.  WCRX plans to commercially launch DELZICOL in March 2013. 

Potential for Endo Health Solutions Acquisition

Fidelity Investments is pushing Endo Health to pursue the sale of the company to Valeant Pharmaceuticals (NYSE: VRX) or Warner Chilcott.  Valeant is a $20 billion company with specialty drugs in neurology and dermatology.  Valeant may be a more difficult fit given their over-leveraged position already.  An article from Bloomberg focused on WCRX, indicating it is the favored acquirer. Estimates show significant EPS accretion for WCRX driven by a lower tax rate at WCRX and the consolidation of operations.  WCRX has hired Goldman Sachs to advise it on the acquisition.

Valuation

WCRX shares are relatively inexpensive, with a P/E of 8.3x full-reported FY13E consensus EPS of $1.76 (FY13E Consensus EPS $3.59).  WCRX has previously focused on returning cash to shareholders via repurchases and dividend (3.55% dividend yield) versus searching for acquisitions.  WCRX is currently in the mix to acquire Endo Health, discussed earlier, which could change this.  That said, the right way to value WCRX is using a DCF versus comparable multiples within specialty pharma.  Each specialty pharma firm has different product lifecycles, so multiple comparison does not work well in this case.  Taking that into account, the shares still appear cheap with most analysts having a price per share of over $18 using a DCF.  The cash flow outlook improved recently with the FDA DELZICOL approval so the valuation should increase as well.

 Conclusion

Warner Chilcott is a good story and the valuation looks attractive.  Estimates are likely headed up behind the FDA approval and could head even higher if the firm acquires ENDP.  Management will provide guidance on 2013 shortly as well which could help drive the shares higher.  However, if WCRX fails in a bid for ENDP, the shares may selloff but the earnings potential would not suffer and that may create a buying opportunity for anyone on the sidelines.


mthiessen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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