Nothing interests a value investor more than bad news. Where there's a lack of enthusiasm, there's usually a cheap stock. Hospira , a leading manufacturer of generic specialty injectable drugs and infusion pumps, looked a likely candidate. Since mid-2010, the company has delivered a litany of bad news but instead of a depressed bargain the share's look surprisingly fit.
A chronic case of unsettling news
The seemingly endless string of U.S. Food and Drug Administration (“FDA”) Warning Letters related to manufacturing defects and quality control issues is probably the most disturbing of Hospira’s recent trend toward bad press.
In April 2010, the company received a letter related to manufacturing facilities located in Clayton and Rocky Mount, North Carolina. The FDA cited good manufacturing practice deficiencies and other quality control and administrative inadequacies at these locations. In March 2013, after the company had undergone some remediation efforts, the FDA issued a follow-up document that identified further areas where improvements at these locations are necessary.
In August 2012, the FDA cited deficiencies at Hospira’s Costa Rica device facility related to the failure to correct and prevent recurrence of nonconforming product among other quality problems. In November 2012, they issued an import alert that prohibited the importation of one of the company’s major infusion pumps into the U.S. from the plant. In February 2013, the import alert was expanded to include three other important pump makes.
In May 2013, the company received a letter related to its pharmaceutical manufacturing facility in India where the FDA identified a number of significant violations.
On its part, Hospira has responded vigorously, submitting comprehensive remediation plans to address the FDA’s issues. On May 1, Hospira announced a new device strategy as part of the revamp. The initiative is aimed to retire older infusion pump models and replace them with more advanced-better quality versions. But on May 9, a letter was received from the FDA that, based on an inspection of the company's Lake Forest, Illinois development site, noted significant concerns with the timeliness of the new strategy and mentioned numerous inadequacies.
The shares are surprisingly well priced
One might expect that Hospira stock would be distressed, given the troubles with the FDA. Instead, the shares seem remarkably healthy.
For its latest quarter, the company reported adjusted net sales of $988 million, excluding the impact of customer allowance expenses associated with the company's device strategy of $104 million, an increase of 2.3 percent compared to 2012. Adjusted income from operations decreased 2.9 percent to $101 million compared to $104 million in the first quarter of 2012. On an unadjusted basis, the company posted an operating loss of $109 million versus $47 million in income the previous year. The decline was mostly due to increased costs associated with the company’s quality remediation plans.
In light of the poor quarter, the shares may already be discounting some of a recovery. Based on company guidance, adjusted to eliminate most quality initiative costs, annual sales are estimated around $4.2 billion with cash earnings of $461 million. Using a cash earnings times a capitalization multiple valuation, reasonable business value would be around $33 to $39 a share at a comparative 12 to 14 market multiple.
Some competitive comparisons
Mylan , is a leader in the U.S. generic drug market and through acquisition and product development has grown sales to $6.8 billion in 2012 from $5.1 billion in 2009. They have a strong generic product pipeline with 178 Abbreviated New Drug Applications pending FDA clearance. The company reported adjusted diluted EPS of $0.62 for their last quarter compared to $0.52 for the prior year period, an increase of 19%. Total revenues increased 3% to $1.63 billion compared to $1.58 billion for last year’s comparable quarter.
Mylan has been pretty assertive with some recent deals. In August 2012, the company and drug major Pfizer established an exclusive long-term strategic partnership to manufacture and market generic drugs in Japan. The company has also cut into Hospira’s turf with a recent $1.6 billion acquisition of Agila Specialties, a developer, manufacturer and marketer of high-quality generic injectable products.
Rarely a market favorite, the company’s shares look moderately priced. Based on yearly revenues of $7.1 billion and earnings of $994 million, they currently trade at a relatively sedate multiple of 12.
Actavis is the world’s third-largest manufacturer of generic prescription drugs. It also has a branded specialty pharmaceutical business that develops and markets a portfolio of approximately 40 products.
The company was recently in the news with a $5 billion offer to acquire Ireland-based Warner Chilcott. The combined company will have around $11 billion in annual revenue as Actavis adds gastroenterology and dermatology products to its portfolio. This is the company’s second deal that combines product expansion with a major tax advantage. Previously called Watson Pharmaceuticals, Actavis took the name of a Switzerland-based generics maker it acquired last year for $5.5 billion. The Watson-Actavis deal cut the company’s tax rate to about 28 percent from 37 percent. The Warner Chilcott purchase could drop the rate another 10 percent.