Generic pharmaceutical manufacturer Actavis Inc (NYSE:ACT) made headlines after confirming that it has entered into early stage discussions with Ireland-based pharmaceutical firm Warner Chilcott Plc (NASDAQ:WCRX) over a possible merger of the two companies. It is worth noting that Actavis is a generics giant, but the latest target of this acquisition-hungry machine is a specialty player.
Understandably, the whiff of talks has fueled the stock prices of both companies. Shares of Warner Chilcott Plc (NASDAQ:WCRX) closed with a nearly 20% jump on Friday of the week before, while Actavis also gained in double digits. Warner Chilcott is a strategic fit for Actavis as the latter has been looking to bolster its presence in the branded drug space and improve its tax structure.
Warner Chilcott Plc (NASDAQ:WCRX) offers both with its portfolio, which includes women’s health and dermatology products. While it is a strategic fit, one should take stock of the fact that Warner Chilcott Plc (NASDAQ:WCRX)’s shares were undervalued while promising strong growth.
Even now, shares trade at a price to earnings multiple of 11.3, which is not very high for a debt-free company. Although its sales declined 13% during the first quarter to $578 million, profits of $113 million remained at same level, indicating robust margins. The only concern with this stock is that the rally has probably played out completely with limited upside potential now.
Actavis’ interest in Warner Chilcott Plc (NASDAQ:WCRX)
Actavis’ interest in Warner Chilcott has once again revived the quest for solid undervalued plays in the pharmaceutical industry. Actavis itself remains undervalued by some standards. Given its paced approach in acquiring profitable businesses, a forward earnings multiple of 12.8 is slated to come down significantly over the next couple of quarters once the company starts reporting consolidated numbers free of acquisition charges.
Earlier this month, the company reported a 24% jump in first-quarter revenue to $1.9 billion, underlined by a 254% surge in international revenue to $608.6 million. Increased costs and charges related to merger and acquisition expenses resulted in a net loss of $102.8 million for the quarter, but its operating margin of 11.4% for the trailing 12 months speaks for itself.
Going forward, Actavis is likely to continue with its aggressive acquisition strategy, but with a focus on targets with better margins. In this context, a debt equity ratio of 1.72 sits in a comfortable zone — not very low, but not prohibitively high as well.
Another undervalued stock
Endo Health Solutions Inc (NASDAQ:ENDP) is the kind of pharmaceutical company competitors would be interested in acquiring. At a forward price to earnings ratio of 8.9, the stock remains undervalued, and while the latest quarterly results did not set the Street on fire, most analysts still have a positive rating on it, albeit with lower price targets.
The company generates roughly 25% of its revenue from generic drugs while more than half of its revenue was contributed by branded drugs in the most recent quarter. The stock has come under pressure after it missed revenue expectations in the first quarter, although the profit of $15.3 million was largely in line with Street estimates.
More importantly, a recent FDA decision not to block generic versions of Endo Health Solutions Inc (NASDAQ:ENDP)’s generic pain killer, Opana ER, would shave $120 million from its annual sales projections. However, these negatives have been factored into the stock price after a 7% drop couple of weeks back.
Foolish bottom line
Actavis represents generic drug makers looking to boost their size through acquisitions. This strategy works initially, but sooner or later, companies realize that there are limitations and then the focus turns on boosting profitability through specialty plays. This makes companies like Endo Health Solutions Inc (NASDAQ:ENDP) better takeover candidates.
The article An Undervalued Play in Pharma originally appeared on Fool.com and is written by Jacob Wolinsky.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
