Description

Viatris Inc. (NYSE: VTRS)  $10.43 on July 19, 2023, my estimate of fair value = $21 (+101%)

Viatris is the 3rd largest manufacturer of generic drugs globally, behind Sandoz (owned by Novartis, but due to be spun-off soon), and Teva (TEVA). 

Viatris, then known at Mylan Labs, merged with Pfizer’s Upjohn division in late 2020, and now gets 65% of its sales from off-patent branded drugs like Lipitor, Viagra, and Xanax.  Those old, branded drugs are slowly waning in sales, but generate high FCF as they dwindle.  Growth from new opportunities in generics with many branded drugs coming off patent industry-wide in the next few years, and with about 33% of Viatris’ sales from emerging markets and China, along with acquisitions (like recently acquired eye care division:  https://www.fiercepharma.com/pharma/jpm23-viatris-lays-out-plans-become-global-ophthalmology-leader-and-pull-down-1-billion-eye ) should more than offset the legacy business fade.  But a return to growth hasn’t happened yet, and the market has essentially lost hope that it will.   

The very low expectations implied by Viatris’ current valuation at $10.43 per share (EV/EBITDA of 6x on consensus est. of $5B EBITDA for 2024, P/FCF 5x on cons. est. of $2.5B, a FCF yield of 20%, dividend yield 4.6%) reminds me very much of the almost exact same valuation at which we purchased Pfizer (PFE) in 2010 which led to about a 70% total return in less than a year.  Back then, the overriding fear was Pfizer’s supposedly insurmountable “patent cliff” beginning when Lipitor was to go off-patent in Nov. 2011, and almost no analyst was modeling growth over the ensuing 5 years.  See this article from the NY Times back then,  https://www.nytimes.com/2011/03/07/business/07drug.html , in which this excerpt captures the sentiment:  “This is panic time, this is truly panic time for the industry,” said Kenneth I. Kaitin, director of the Center for the Study of Drug Development at Tufts University in Medford, Mass. “I don’t think there’s a company out there that doesn’t realize they don’t have enough products in the pipeline or the portfolio, don’t have enough revenue to sustain their research and development.”

The patent cliff was real, and Pfizer’s sales dropped significantly after 2010, dropping annually for 5 years in a row, so the analysts were right to be pessimistic on the sales trend.  But, Pfizer cut costs, so EBITDA and FCF fell less than they would have otherwise, and the stock doubled the 2010 low by early 2013.  The valuation near the low of 2010 where we bought Pfizer (just under $14) proved unsustainably low, despite the hard times to come.  I think Viatris likewise represents an untenably low valuation, even if the pessimistic consensus on the sales trend proves correct, as was very much the case with Pfizer after 2010.  

Generic drug makers have lost margin from pricing pressure due to foreign competition and consolidation amongst the largest wholesale buyers.  But consolidation amongst the generic manufacturers will likely increase soon as well (especially given current valuations), which should provide some offset in terms of bargaining power as well as cost synergies.  Teva tried to buy Mylan (Viatris’ predecessor) for more than 8x the current stock price in 2015 (11x EBITDA), and Mylan rejected the deal, which clearly proved a regrettable decision after 2015 as shown in the chart below (only 3 directors from 2015 remain of the current 11).  I wouldn't be surprised if Sandoz, once it's spun-off from Novartis soon, were to merge with Viatris at some point.

My estimate of fair value for Viatris at $21 reflects a targeted EV/EBITDA multiple of 8.25x, and P/FCF multiple of 10x.  I don’t see that as a very demanding valuation expectation for a recession-proof business with a 58% gross margin and 33% EBITDA margin of which 50% converts to free cash flow (FCF).  My fair value estimate of $21 is 101% higher than the last trade, not counting the 4.6% dividend yield.  Also, Viatris is quickly deleveraging and buying back stock, as shown in this excerpt (see below) from their Q1 2023 results presentation this past May.

Keep in mind Viatris had total sales of $16.2B in 2022, of which $5B came from generics:

Catalyst

Continued deleveraging to benefit equity value, while M&A and R&D prompt a return to sales growth sparking valuation normalization. Sandoz spin-off in Q4 2023.