Viatris – Stock Analysis

Viatris (VTRS) was formed through the combination of Mylan N.V. and Pfizer's Upjohn business.

In my June 3, 2021 post, I explain my reasoning for taking a position in this company.

I now revisit VTRS given the August 9 release of Q2 and YTD2021 results and guidance.

Viatris - Stock Analysis - Business Overview

VTRS's FY2020 Form 10-K provides a comprehensive overview of the company in Part 1.

In addition to the overview in my previous post, I provide the following additional information.

Pipeline

VTRS has a portfolio of generic drugs and this segment of the business is predominantly no-moat 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. As a result, VTRS anticipates a decline in revenue from existing brands because of a loss of exclusivity and extensive competition from other generic drug manufacturers.

VTRS counters this anticipated erosion through extensive research and development. More than 2,000 people, of which many are researchers and regulatory and clinical experts, work collaboratively across 12 different R&D centers around the world, including 10 technology-focused development sites and 2 global R&D centers.

Its R&D and medical platform seek to deliver new product opportunities (brand, complex generic, biosimilar and generic) across all of VTRS's markets and to develop new expanded opportunities for products in the existing portfolio.

In addition, some of its drugs receive approval to be interchangeable. This means a drug can be used for another medical purpose.

The product pipeline (refer to pages 12 - 15 in the Q2 201 Earnings Presentation) includes a variety of dosage forms.

Although the company is committed to generics and specialty products, a greater portion of VTRS's investments 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.

On the new product front, VTRS has identified about 30 products of which 6 are scheduled for filing in 2021 and 3 have already been filed for regulatory approval. To date in FY2021, VTRS has generated ~$0.224B in new product revenue. Management stated on the Q2 earnings call that the company remains on track for ~$0.69B in new product revenue for FY2021.

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.

FDA Approval of Insulin Glargine-yfgn

Speaking of the product pipeline, VTRS partnered with Bangalore-based Biocon Biologics Ltd., a subsidiary of Biocon Ltd., to develop Semglee®, the first interchangeable biosimilar insulin glargine-yfgn injection for the treatment of diabetes.

NOTE: Biocon, based in Bangalore, India, is India's largest biopharmaceutical company.

The interchangeable Semglee® product will allow the substitution of Semglee® for the reference product, Lantus®, at the pharmacy counter. VTRS anticipates product introduction before the end of 2021.

VTRS is eligible to have exclusivity for 12 months before the US Food and Drug Administration (FDA) can approve another biosimilar interchangeable to Lantus.

In becoming the first to receive the FDA's approval of an interchangeable biosimilar product in the US, VTRS now broadens access to this important diabetes medicine for patients, physicians, payers and providers.

Litigation

Litigation is common in business and especially in the pharmaceutical sector.

For the first 6 months of FY2021, VTRS has incurred litigation settlements and other contingencies in the amount of ~$46 million with ~$42.4 million of this having impacted cash flow from operations. These litigation costs are predominantly related to facts and circumstances that existed as of the date of the combination of Mylan N.V. and Pfizer's Upjohn business.

The litigation section in VTRS's Q2 2021 Form 10-Q commences on page 44 of 85. The first item in the lengthy litigation list is the EpiPen® Auto-Injector Litigation.

On June 23, VTRS announced that Mylan won significant summary judgment rulings in the Kansas EpiPen® Class Action. The court's decision dismisses all of the plaintiffs' claims under the federal RICO statute. The court also dismissed claims alleging that Mylan foreclosed branded competition through rebate arrangements with pharmacy benefit managers.

Investors can read the details of other litigation matters on pages 44 - 52!

Viatris - Stock Analysis - Financials

Q2 2021 and YTD Results

On August 9, VTRS released its Q2 and YTD results; the accompanying Earnings Presentation is accessible here. In addition, more comprehensive information is found in the Q2 2021 Form 10-Q.

While performing financial analysis, 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 GAAP earnings in our VTRS analysis, we would likely discard it as a potential investment. YTD GAAP loss of $1.09/share is predominantly attributed to ~$2.74B 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).

 

As we see in the Valuation section of this post, the analysts which cover VTRS have made various adjustments to arrive at their adjusted diluted EPS estimates.

Credit Facilities

In my June 3 post, I indicate VTRS's high leverage is a weakness; page 32 of 85 in VTRS's Q2 2021 10-Q reflects a schedule of the company's long-term debt.

The strong YTD FCF, however, has enabled VTRS to repay ~$1.15B of debt; refer to debt-related entries under the cash flows from financing activities within the Condensed Consolidated Statements of Cash Flows found on page 11 of 85 of the Q2 2021 10-Q. This is a good start toward VTRS's commitment to achieving $6.5B in debt repayment by 2023.

In July 2021, VTRS entered into a YEN Term Loan and the 2021 Revolving Facility. Terms are substantially identical terms to the credit facilities negotiated in 2020 with the following exceptions:

• the maturity of both the YEN Term Loan and the 2021 Revolving Facility is July 2026 (a 5-year term);
• pricing has been adjusted to reflect current market prices (which are generally more favourable); and
• the maximum leverage ratio as of the end of any quarter is now set at 4.25 to 1.00 for each quarter ending after June 30, 2021 through and including June 30, 2022, 4.0 to 1.00 for each quarter ending after June 30, 2022 through and including December 31, 2022 and 3.75 to 1.00 thereafter, except in circumstances as defined in the related credit agreement.

Operating Cash Flow (OCF)  and Free Cash Flow (FCF)

VTRS generated $0.559B in Q2 and $1.41B YTD of net cash provided by operating activities.

FY2021 Guidance

Based on the strong performance in the first half of FY2021, management has raised revenue, adjusted EBITDA, and free cash flow guidance.

A key metric underlying financial guidance is the adjusted effective tax rate. This has been lowered to 17% - 18% due to the favourable mix of income across the company's tax jurisdictions.

FY2021 US GAAP net cash provided by operating activities guidance is estimated to be $2.8B - $2.95B with a ~$2.875B midpoint.

On the Q2 earnings call, the company's CEO indicated:

'We have strong momentum going to the second half of the year and we will be once again open to reassessing financial guidance at the end of the third quarter.'

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.

Viatris - Stock Analysis - Dividends and Share Repurchases

Dividend and Dividend Yield

VTRS distributed its inaugural quarterly dividend of $0.11/share on June 26. The second quarterly dividend of $0.11/share is payable on September 16.

The current quarterly $0.11/share dividend provides investors with a ~2.9% dividend yield using the current ~$15 share price.

Share Repurchases

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.

At the time of my previous post, shares were trading at $15.46. This was the adjusted diluted EPS guidance from 11 brokers:

• 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 is ~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.

The current share price is ~$15 and the current FY2021 - FY2023 adjusted diluted EPS guidance is:

• FY2021 - 15 brokers - mean of $3.57 and low/high of $3.34 - $3.80. Using the mean estimate, the forward adjusted diluted PE is ~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 is ~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 is ~3.8.

I place no reliance on the FY2023 earnings estimates because much can happen within two years thereby rendering these estimates meaningless.

I think VTRS is an attractive investment from a valuation perspective even if it achieves the upper end of the FY2021 and FY2022 forecast ranges.

Viatris - Stock Analysis - Final Thoughts

I have reiterated the risk of investing in grossly overvalued companies in several previous posts. VTRS is at the other extreme with a valuation that suggests it belongs in the scrap pile. I disagree which is why I initiated a position in a 'Core' account in the FFJ Portfolio in June.

On the Q2 2021 earnings call, management indicates that based on:

• the 3-year cash flow horizon;
• a gradual reduction in one-time costs;
• the continued strengthening of the base business; and
  
• continuous cash improvement opportunities

it remains confident in its ability to repay $6.5B of debt and to continue to increase the dividend.

VTRS is certainly not of the same quality as most of my other holdings. I, however, think this company's financial picture will improve significantly over the next couple of years. If this happens, I expect investors to warm up to VTRS and a share price increase.

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 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 own 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.