- Eye care, Gastrointestinal and Generics all did very well in the first quarter. I still see the company as heavily undervalued.
- The S&P 500 printed a firm cycle low on the 19th of May. Biotech and specifically undervalued stocks like Allergan should outperform.
- I believe the announced $10 billion share repurchase program is an excellent initiative which will improve earnings accordingly.
I was impressed with Allergan's (NYSE:AGN) first quarter results which should definitely give the doubters some food for thought. It is rare to pick up a company with a wide moat trading at such a discount to its mean valuations but we are in this position primarily because of the downturn in the biotech sector since mid-2015 and also because of the recent breakdown in the Pfizer deal. For example, the stock (which is currently trading at $222) has a book value per share of around $180, which puts the price/book value per share well below the industry average.
Furthermore, its wide moat is derived from the company's dominance in the aesthetic and ophthalmology sectors (where the barriers to entry are extremely high). Moreover, the company has extensive reach in the primary care market but what I really like about the company's fundamentals are the products that are coming down the track. Its drug pipeline is very strong and once the $35 billion+ comes off the Teva deal in the Summer, I see the company's pipeline getting even stronger. Here are more strong reasons why Allergan should be part of your portfolio.
In this type of business model where revenue is growing at a healthy clip (revenue beat estimates in the first quarter growing by almost 50%), it is crucial to monitor debt levels and gross margins to get a feel of where the stock could potentially get to in years to come. Well, revenue (trailing twelve-month average at $16.3 billion) is currently double that of 2013 and gross margins are well up (72% currently) and debt to equity is 0.53 which again is lower than 2013 levels (0.89).
This illustrates to me that the company is really scaling itself in a productive way and the more it expands its production lines, the more you feel those gross margins are going to increase over time. In relation to the company's drug pipeline, investors should look out for progress in ongoing clinical trials to ensure generic competition doesn't creep on the company in certain areas but here is where you have to back the company's acquisition track record to date.
In terms of the biotech asset class, this sector has basically led the bull run across all asset classes since 2009. The biotech ETF iShares NASDAQ Biotech Index (NASDAQ:IBB) suffered a 39% drop since July of last year but I feel that severe correction is over. Why? Well, as I have written in previous articles, I believe the S&P 500 (INDX:SPAL) has just started a brand new daily cycle (bottom was printed on Friday) and the biotech sector has followed on convincingly. Sentiment became excessively pessimistic (something we always see before turning points) before the trend change (see chart).
Source : Sentimentrader
Furthermore, the weekly stochastics on the IBB chart are still at over sold levels. This statistic needs to be at the high point of its range before we get a cycle top. Furthermore, since Allergan is more oversold than the sector it is residing in, I expect it to outperform throughout the rest of this cycle.
Thirdly, the decision to authorize $10 billion in share buybacks is a good move in my opinion especially when you consider the current valuation of the stock. Buybacks make sense when management feels the stock is undervalued plus a reduced share count will automatically improve earnings per share in upcoming quarters. Moreover, I liked CEO Brent Saunders' recent comments about concentrating more on its own business and equity to ensure it manages its own portfolio of drugs as productively as possible. The old Allergan would already be preparing for acquisitions as capital from the Teva deal is nearly ready to fall due. However, Saunders reiterated that debt ($8 billion will be paid down) and equity are two of his highest priorities which will continue to receive continuous funding to ensure stability back at base.
To sum up, Allergan stock is a strong buy mainly because of its valuation, the strong fundamentals of the sector it is operating in and an attractive drug pipeline. Its recent first quarter earnings on the surface looked very impressive and there is absolutely no sign of growth slowing down anytime soon. My recommendation is to get on board Allergan stock before its too late.