Contents
The acquisition of shares in an overvalued company creates the potential risk for poor investment returns. At the other end of the spectrum is a company trading at a ridiculously low valuation. One company with a ridiculously low valuation is Viatris Inc. (VTRS). In this article, I look at Viatris' risks and upside potential.
Viatris - Risks And Upside Potential - Business Overview
An overview of VTRS's industry, customers, business strategy, solutions and risks is found in Part 1 of the FY2020 10-K. Additional information is available in the following:
- Q1 Earnings Release and Q1 2021 Investor presentation;
- Q1 2021 10-Q;
- March 1, 2021 Investor Day conference presentation; and
- recent healthcare conference presentations.
Viatris - History and Mission
VTRS launched November 16, 2020, following the combination of Mylan N.V. and Pfizer's Upjohn business. Through the combination of these two complementary legacy companies, VTRS has the scientific, manufacturing and distribution expertise with proven regulatory, medical and global commercial capabilities to deliver high-quality medicines to patients in more than 165 countries and territories.
VTRS bills itself as a new kind of global healthcare company whose mission is to:
'empower people worldwide to live healthier at every stage of life by expanding access to medicines regardless of geography or circumstance; advancing responsible, sustainable operations and targeted innovation to improve patient health; and leveraging its collective expertise to connect more people to more products and services.'
Viatris - Unparalleled Global Reach
VTRS possesses end-to-end experience across the total product life cycle. This includes global regulatory licensing, launch, growth and post-approval lifecycle management. Its research, development and medical platform seek to maximize the impact of the existing product portfolio by examining whether there is an opportunity for new indications, label extensions, product formulations, and market registrations for its products.
The company also uses its platform to determine whether there is an opportunity to integrate new products into the portfolio. The manufacturing of active pharmaceutical ingredients (APIs) and finished dosage forms is performed by a combination of internal and external manufacturing operations. Much of VTRS's manufacturing is vertically integrated which means it produces many of its own APIs and finished dosage forms. On occasion, however, resources are available from only a single supplier. Like many pharmaceutical companies, VTRS supplements its production footprint through arrangements with other manufacturers.
Viatris - Reporting Segments
VTRS has 4 reporting segments.
It markets prescription brand drugs, generic drugs, complex generics, biosimilars and active pharmaceutical ingredients and offers:
- quality treatment options across more than 10 major therapeutic areas covering a wide variety of noncommunicable and infectious diseases;
- support services such as diagnostic clinics, educational seminars and digital tools to help patients better manage their health; and
- a broad and diverse range of treatment options across all therapeutic areas. Many categories contain several products in a range of dosage forms, formulations and delivery systems that allow physicians to tailor care for optimal treatment.
The generic drugs business is a predominantly no-moat industry with low entry barriers and multiple commodity-like products. The lack of pricing power and lack of a moat has resulted in a ~50% contraction of the generics market over the last several years.
Viatris - Product Pipeline
VTRS has a broad and diverse product pipeline. The new product revenue is $0.69B YTD. This is from products launched in 2020 and 2021.
VTRS expects to have ~200 product submissions and approvals in a year. It also has a very high probability of technical and regulatory success. This reduces its dependency on one 'make-or-break' kind of pipeline project.
In addition, some of its drugs receive approval to be interchangeable meaning a drug can be used for another medical purpose.
Viatris - Global Healthcare Gateway
The purpose of VTRS's Global Healthcare Gateway™ is to offer partners ready access to expanded markets through an innovative global infrastructure that connects people around the world to the high-quality medicines and services they need as healthcare needs evolve.
This gateway is powered by VTRS's best-in-class manufacturing, scientific and legal expertise and proven commercial capabilities with unparalleled reach.
Through the Global Healthcare Gateway™, VTRS wants to be the Partner of Choice™ for companies looking to expand access to their assets.
Viatris - Financials
Q1 2021 Results
Links to VTRS's Q1 Earnings Release, the accompanying Investor presentation, and the Q1 10-Q are at the beginning of this post.
FY2021 Guidance
Management states that FY2021 could be a 'trough year'. During the 2021 RBC Capital Markets Global Healthcare Conference, management explains there is natural erosion in the base business. This erosion is expected to be replaced from the company's pipeline of drugs. Based on management's outlook, it is confident $6.2B of EBITDA is the 'floor' investors can expect.
FY2021 expectations in the 4 regions are:
- Europe - stable with growth expected for the remainder of the year;
- North America - stable or a slight decline because of various drugs that have experienced a loss of exclusivity;
- JANZ - large decline because of drugs that have experienced a loss of exclusivity;
- China - a slight decline. This is because of China's National Healthcare Security Administration (NHSA) Universal Reimbursement Payment arrangement. For a drug manufacturer to have its drugs included in China’s state medical insurance scheme and to be included on the National Reimbursement Drugs List (NRDL), drug manufacturers have agreed to cut their prices by an average of ~50.64% for ~119 medicines. Although profit margins are expected to decline, this change could potentially lead to a massive leap in sales.
Being included on the NRDL in China which is updated annually, could potentially boost demand for medicines because patients could be reimbursed for a significant portion of the costs.
The average sales of medicines added to this list the last time it was updated jumped by ~2,000% during a nine-month period in 2020.
All 4 regions experience a unique impact from the loss of exclusivity. VTRS, however, is not overly reliant on any particular region. Furthermore, a good geographical balance enables it to absorb and capitalize on opportunities.
It is encouraging that guidance does NOT assume any combination synergies in FY2021 even though opportunities exist.
Operating Cash Flow (OCF) Free Cash Flow (FCF)
The following is FY2021 OCF and FCF guidance.
The company is committed to returning capital to shareholders. The plan is for an expected dividend of at least 25% of free cash flows, based upon GAAP operating cash flow minus capital expenditures, beginning after Q1 2021; the expectation is for the dividend to grow thereafter.
$2.15B is the mid-point of FY2021 FCF guidance. Within this amount is ~$1.5B of one-time restructuring, integration, costs to achieve synergies and legal/settlement/tax costs. The first 3 costs represent ~66.6% of the $1.5B; these are to drop dramatically by the end of the 3rd fiscal year following the business combination. This gives management confidence that cash flow will improve in the next couple of years.
Viatris - Credit Ratings
VTRS's high leverage is an issue. Page 122 of 321 in VTRS's FY2020 10-K reflects a schedule of the company's long-term debt of which $6.5B is to be repaid by the end of FY2023.
- Moody's assigns Baa3 long-term debt credit rating.
- S&P assigns BBB- long-term debt credit rating.
Both ratings are the lowest tier in the lower medium grade category and are the lowest investment-grade tier.
- Fitch assigns a BBB rating which is one level higher than the Moody's and S&P ratings.
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 and to repay $6.5B of debt by the end of FY2023. This should lead to rating upgrades.
Dividend and Dividend Yield
One of management's priorities is to increase the dividend. Achieving synergy targets and the reduction/elimination of integration expenses should lead to an increase in FCF to support dividend increases.
On May 10, 2021, VTRS announced its inaugural quarterly dividend of $0.11 payable on June 26 to stockholders of record at the close of business on May 24, 2021.
The $0.11/quarter, or $0.44/year, dividend provides investors with a ~2.85% dividend yield based on the current $15.46 share price. This dividend is consistent with the target 25% of the mid-point of FCF guidance for the year.
FY2021 FCF guidance is $2B - $2.3B and the mid-point is $2.15B. The diluted weighted average shares outstanding are 1.2075B so FY2021 FCF/share is $1.78. 25% of this is ~$0.44/share which is how management arrives at the new quarterly dividend.
Investors should not expect much of a reduction in the diluted weighted average shares outstanding over the next couple of years. Share repurchases are not a priority as capital deployment is to be directed toward:
- Dividend growth;
- Debt reduction;
- New pipeline investment - enhancing and increasing investment in internal R&D and the Global Healthcare Gateway®; and
- M&A - opportunistic business development.
Potential share repurchases are to only be expected after the target long-term leverage ratio of 2.5 times or less is achieved (refer to page 6 of 174 in the March 1, 2021 Investor Day conference presentation).
Viatris - Valuation
It is of little use to rely on historical data to value VTRS because VTRS is a much different company following the combination of the Mylan N.V. and Pfizer's Upjohn businesses.
Since so many costs are non-recurring I am not relying on Q1 GAAP earnings. I am using adjusted earnings estimates from multiple brokers for valuation calculation purposes.
FY2021 guidance from 11 brokers is 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 is ~4.36 when we use the mean estimate.
FY2022 guidance from 11 brokers is 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.
If the company can meet its objectives, I expect the investment community will begin to look upon this company more favourably and we will witness an expansion in valuation.
Viatris - Risks and Potential Upside - Final Thoughts
This company is of lesser quality than the other holdings within the FFJ Portfolio and top 30 holdings. However, after analyzing VTRS's risks and potential upside, I acquired 400 shares for one of the 'Core' accounts within the FFJ Portfolio.
The higher risk by reason of the company's debt level should diminish in the next 2 years with $6.5B of debt repayment by the end of 2023.
VTRS's pipeline consists of many drugs that have lost their exclusivity but the company has a strategy to address this. There are ~200 drug submissions and approvals annually. This should enable VTRS to maintain/grow its broad pipeline to gradually increase revenue.
Annual dividend increases should transpire since VTRS should be able to generate strong FCF.
Share buybacks will be off the table for the next couple of years but might become another method by which to reward shareholders.
This stock will likely trade in a narrow range until management can demonstrate the company's ability to meet its objectives. Once this occurs, I envision an expansion in VTRS's earnings multiple.
Because VTRS's earnings multiple is so low I envision a minimal drop in VTRS's share price if we experience a long-overdue market correction.
My decision to invest in VTRS does not mean I am changing my investment strategy. My priority is to invest in high-quality companies.
Stay safe. Stay focused.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I and 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 own research and due diligence. Consult your financial advisor about your specific situation.
