These are rough times for the medical world. Major pharmaceutical companies like Pfizer (NYSE:PFE) and Lilly (NYSE:LLY) and prominent device companies like Medtronic (NYSE:MDT) and Covidien (NYSE:COV) are limping and wheezing as investors worry about growth prospects in a tough economy and an even tougher FDA.
It would be reasonable to think that if these companies (that are largely protected by serving legitimate medical needs and getting full reimbursement from health insurance) are struggling, a company with more exposure to elective and self-pay products would be in even worse shape. Well, that does not seem to be the case for Allergan (NYSE:AGN). Although Allergan is seeing a hit to growth, Wall Street still seems smitten with this largely cosmetic-oriented company.
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A Saggy (But Positive) Quarter
Allergan did manage to surpass the consensus expectations for the third quarter. Product sales rose almost 6% on an as-reported basis, with pharmaceutical sales growing more than 5% and device sales up more than 8% (both were higher on an ex-currency basis). Allergan foresees solid growth in its pharmaceutical portfolio (from drugs like Restasis and Lumigan) and Botox was up more than 4%, despite competition from Medicis (NYSE:MRX).
Below the top line, Allergan managed to squeeze out a bit more leverage. Gross margins improved about 250 basis points on a non-GAAP basis, and this company does have excellent gross margin (roughly 86%). Non-GAAP operating expenses came in favorably, and the company saw 15% operating income growth even while allocating more resources to R&D. Investors should note, though, that the company reported a loss on a GAAP basis due to a settlement with the DOJ and a write-down of assets related to the Sanctura bladder drug.
The Road Ahead
Allergan is managing mid-single digit top-line growth, even in a market that is relatively hostile to products with large co-pays like Botox and obesity surgery. With the company rolling out even more applications for Botox (the next being for chronic migraines), it looks like the company is determined to make the most of this product platform (and Botox is already close to 30% of the business).
It does remain to be seen, though, if the company can develop some new avenues for growth. Restasis has been a success, but Sanctura has not, and in my opinion, it does not seem probable that Latisse will be. Likewise, a rebound in the economy will be a boon for the obesity and breast aesthetics businesses, but they are small contributors on a relative basis. All in all, 60% of the company's growth is coming from Lumigan and Restasis and that could become a vulnerability for the company.
The Bottom Line
Allergan is a fine company that is enjoying the love of Wall Street. Where most high-quality medical franchises are trading for six to eight times EBITDA, Allergan trades at over 15 times trailing EBITDA. That is a rich multiple, and a discounted cash flow analysis backs up the idea that these shares are overvalued. Only time will tell if Allergan can maintain these lofty multiples, but value hounds are probably better-served looking among the cheaper and downtrodden names rather than paying up for Allergan. (To learn more, see Measuring The Medicine Makers.)
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