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In my August 10, 2021 Viatris (VTRS) stock analysis I reviewed Q2 and YTD financial results and the company's valuation based on guidance.
I now revisit VTRS following the November 8, 2021 release of Q3 and YTD 2021 results and revised FY2021 guidance.
Viatris - Stock Analysis - Business Overview
VTRS's FY2020 Form 10-K provides a comprehensive overview of the company in Part 1.
Investor Event
On January 7, 2022, VTRS will hold an investor event at which time management will present its two-phased strategic roadmap.
Phase 1 (2021 – 2023) of the strategic roadmap will address:
- Financial guidance, targets and metrics for 2022 and 2023;
- Free Cash Flow generation and Phase 1 capital allocation priorities; and
- Returning capital to shareholders and repaying $6.5B of debt.
Phase 2 of the strategic roadmap will address the 2024+ timeframe.
- Overview of catalysts for future growth;
- Future capital allocation priorities to maximize and further unlock shareholder value;
- Specific details of organic opportunities, in-depth pipeline discussion; and
- Priorities for inorganic business development (Global Healthcare Gateway®)
Pipeline
Key pipeline updates for VTRS's Biosimilars, Complex Products, and Complex Injectables are provided in the Q3 2021 Earnings Presentation.
As noted in my August 10th post, the company is committed to generics and specialty products. A greater portion of VTRS's investments, however, is being focused on complex or difficult-to-formulate products, such as biosimilars, as opposed to commodity products, such as conventional oral solid dosage forms.
Collectively, the investments in all of VTRS's research efforts represent more than 2,000 products under development or pending approval around the world.
With ~200 product submissions and approvals anticipated in a year, VTRS has a very high probability of technical and regulatory success. This reduces its dependency on one 'make-or-break' kind of pipeline project.
Viatris - Stock Analysis - Financials
Q3 2021 and YTD Results
My analysis is based on information derived from:
Optimizing cash flow generation continues to be a priority. Management expects continued strong performance, a reduction in one-time costs, and continued improvements in cash flow conversion will lead to cash flow growth in the coming years.
Analysts will make several adjustments to a company's financial statements to make them comparable with other companies. These adjustments are required due to the different accounting choices made by the firms, differences in accounting standards, and to account for non-recurring events.
Were we to rely solely on VTRS's GAAP earnings, we would likely discard it as a potential investment since the company is not profitable on a GAAP basis. YTD GAAP loss of $0.83/share ($1.09/share at the end of Q2 2021) is predominantly attributed to ~$3.757B (~$2.74B at the end of Q2 2021) of depreciation and amortization expenses. This non-cash charge impacts GAAP earnings but has no impact on the company's operating cash flow.
Given that VTRS has ~$40B of Intangible Assets and Goodwill to amortize, it most likely will not generate GAAP earnings within the next few years. In fact, VTRS's credit arrangements include a maximum consolidated leverage ratio financial covenant requiring maintenance of a maximum ratio of consolidated total indebtedness as of the end of any quarter based on consolidated EBITDA (earnings before interest, tax, depreciation, and amortization).
Source: VTRS - Q3 2021 Earnings Presentation - November 8, 2021
Source: VTRS - Q3 2021 Earnings Presentation - November 8, 2021
Credit Facilities
VTRS remains committed to strengthening the Balance Sheet; this is a key priority in Phase 1 (2021 – 2023) of the strategic roadmap.
Page 33 of 86 in VTRS's Q3 2021 10-Q reflects a schedule of the company's long-term debt. With YTD FCF of $2.234B, VTRS has repaid $1.9B of debt YTD, including $0.73B in Q3.
Operating Cash Flow (OCF) and Free Cash Flow (FCF)
At the end of Q2, VTRS had generated $1.408B YTD net cash provided by operating activities and $1.269B in FCF. We see from the following that both YTD levels have increased significantly in Q3.
Source: VTRS - Q3 2021 Earnings Presentation - November 8, 2021
Q3 FCF of $0.965B exceeded expectations. This strong result is attributed to strong operational performance and cash flow improvement initiatives. Furthermore, one-time costs were lower due to the timing of events between Q3 and Q4. Capital expenditures also came in below expectations partly due to COVID-related global supply chain delays.
FY2021 Guidance
On the Q2 earnings call, management said it would reevaluate VTRS's 2021 financial guidance at the end of Q3. Based on the YTD strong performance, some elements of FY2021 financial guidance have been favourably amended. These revisions have led to the upward revision of the lower end of the brokers' adjusted diluted EPS estimates for FY2021 - FY2022 from the time of my August 10th post.
Management's revisions are made despite an anticipated significant reduction in FCF in Q4 relative to Q3. The lower FCF projection for Q4 is due to lower adjusted EBITDA attributed to one-time cash costs, semi-annual interest payments, and the ramp-up of capital expenditures.
Management also continues to remain confident that $6.2B of annual adjusted EBITDA is the true floor of the business.
Source: VTRS - Q3 2021 Earnings Presentation - November 8, 2021
VTRS's Q4 adjusted gross margin is expected to decline to ~58% from 60% in Q3 due to the evolution of the product portfolio mix.
Based on additional cash flow improvement initiatives and the expected reduction in one-time cash costs, VTRS remains highly confident it will generate an aggregate of over $8B of FCF in FY2021 - FY2023.
Viatris - Stock Analysis - Credit Ratings
The domestic unsecured long-term debt ratings assigned by the major rating agencies remain unchanged from the time of my previous post.
- Moody's assigns Baa3 long-term debt credit rating;
- S&P Global assigns BBB- long-term debt credit rating; and
- Fitch assigns a BBB rating which is one level higher than Moody's and S&P Global's ratings.
Moody's and S&P Global's ratings are the lowest tier in the lower medium grade category and are the lowest investment-grade tier.
All three ratings define VTRS as having the ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to meet its financial commitments.
I generally invest in companies with higher ratings. However, VTRS's commitment is to maintain investment-grade credit ratings. I also anticipate rating upgrades if VTRS achieves its objective to repay $6.5B of debt by the end of FY2023.
Dividend and Dividend Yield
VTRS is a relatively new company so its dividend history is brief.
VTRS has returned $0.266B in YTD dividends to shareholders and the plan is to continue to increase the dividend, subject to board approval.
In conjunction with the release of Q3 2021 results, VTRS announced its 3rd quarterly consecutive $0.11/share dividend. This dividend is payable on December 16, 2021 to shareholders of record at the close of business on November 23, 2021.
The dividend yield is ~3% on the basis of the current ~$14.50 share price.
Share repurchases are unlikely to occur any time soon since the company has other priorities it must address (ie. debt reduction).
Viatris - Stock Analysis - Valuation
I reference the comments within the Financials section of this post in which I provide my thoughts on VTRS's adjusted earnings estimates from analysts given that VTRS has not, and likely will not for quite some time, generate GAAP earnings.
When I initiated a position in VTRS, shares were trading at $15.46 and adjusted diluted EPS guidance from 11 brokers was:
- FY2021 - a mean of $3.55 and a low/high range of $3.34 - $3.80. With shares trading at ~$15.46, the forward adjusted diluted PE was ~4.36 when we use the mean estimate.
- FY2022 - a mean of $3.70 and a low/high range of $3.32 - $4.05 thus giving us a ~4.18 forward adjusted diluted PE when we use the mean estimate.
At the time of my August 10 post, the share price was ~$15 and the FY2021 - FY2023 adjusted diluted EPS guidance derived from the 2 discount brokerage platforms I use was:
- FY2021 - 15 brokers - mean of $3.57 and low/high of $3.34 - $3.80. Using the mean estimate, the forward adjusted diluted PE was ~4.2.
- FY2022 - 14 brokers - mean of $3.71 and low/high of $3.32 - $5.05. Using the mean estimate, the forward adjusted diluted PE was ~4.
- FY2023 - 11 brokers - mean of $3.93 and low/high of $3.62 - $4.31. Using the mean estimate, the forward adjusted diluted PE was ~3.8.
Shares are now trading at ~$14.50 and the valuation based on adjusted diluted EPS guidance is:
- FY2021 - 13 brokers - mean of $3.71 and low/high of $3.6 - $3.85. Using the mean estimate, the forward adjusted diluted PE is ~4.
- FY2022 - 13 brokers - mean of $3.74 and low/high of $3.46 - $4.06. Using the mean estimate, the forward adjusted diluted PE is ~3.9.
- FY2023 - 11 brokers - mean of $3.89 and low/high of $3.45 - $4.31. Using the mean estimate, the forward adjusted diluted PE is ~3.7.
Viatris - Stock Analysis - Final Thoughts
My rationale for investing in this company through a 'Core' account in the FFJ Portfolio has not changed.
VTRS's low valuation is because this is not a high-growth business. Nevertheless, I think this company still has the potential to generate a long-term total investment return in excess of the rate of inflation.
The company is expected to significantly reduce its debt over the next couple of years and management has stated it is committed to increasing the dividend.
If the company performs as management expects, I think the investment community will start to look upon VTRS more favourably and we will witness an expansion in its valuation.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long VTRS.
Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.
