Forest Laboratories (FRX), along with its subsidiaries, develops, manufactures and sells both generic and branded drugs that require physician prescriptions, along with over the counter type pharmaceuticals. Forest Laboratories is a U.S. based company, founded in 1954 and incorporated two years later began as a producer of vitamin tablets and has grown to be a leader in the pharmaceutical industry. Some of the best-known brand names are shown below:
Benjamin Graham’s Take:
Forest Labs and Benjamin Graham’s Defensive Strategy combine to have nearly a perfect score. As a reminder, Graham’s Defensive Strategy consisted of:
1. Graham wanted companies that were not too small for the defensive type person and suggested
companies that had not less than $100 million of annual sales ($50 million for a public utility). Today, that number would probably best be translated to at least $300 million in today’s dollars.
2. A current ratio of at least 2-1. The current ratio is the ratio produced by taking current assets and dividing them by current liabilities.
3. Long-term debt should be equal to or less than net current assets or, essentially, long-term debt
less than working capital.
4. Earnings stability, meaning that there should be positive earnings for each of the last 10 consecutive years.
5. Twenty years of dividend payment. This becomes more difficult today, because of the vast number of companies reinvesting large portions of their earnings back into the company. Today we would be happy to find companies with a dividend history of 7-10 years.
6. Earnings growth of approximately 30-33% over a 10-year period or approximately 3% per year. If you read carefully, Graham did not take the first and last year to discover his average. He would take the first three years and get an average, the last three years and get an average and then base his 10-year earnings growth on those two numbers. I will be using five-year rates.
7. The price/earnings ratio should not be more than 15 over the past three years.
8. Finally, he suggested that the price to book value not exceed 1.5; however, he allowed for a slight alteration if multiplying the P/B times the P/E did not produce a product greater than 22.5. Therefore, as
an example, this would allow a P/B of 2 and a P/E of 9, resulting in a slightly higher P/B, but allowed under this method.
Sales: $4,669 million
Current Ratio: 4.0
LTD to Net Current Assets: LTD = $ 0
Long Term Earnings Growth: Approx. 10% annually, with no negative years
P/E X P/B: 14.28
The only exception to an absolute perfect score is the lack of a dividend, but Forest Laboratories makes up for it with excellent financials and great management.
Other Guru ownership consists of Joel Greenblatt with his Magic Formula, Carl Icahn, Edward Owens and John Hussman. Both Icahn and Owens have taken particular interest in this stock, while Icahn is endeavoring to seat four members on the existing board of nine.
In addition to these investors and along with the Graham screen, this stock also passes the Peter Lynch screening method and actually receives high marks for their net cash position. Lynch preferred stocks that had an abundance of this net cash position. Described as cash and marketable securities minus long-term debt, the higher a company could attain the better. Forest Laboratories has a high net cash to price ratio of 41.42%. Inventory to sales, another key Lynch metric, indicates that inventory decreased from the prior year.
Howard Solomon, chairman, CEO and president is a very important part of what makes Forest Laboratories special. Solomon’s tenure at the company is 34 years, an amazing feat that few CEOs can brag about. Further, Forbes has recognized Solomon as one of the top members of the Forbes CEO 20-20 club, with tenure of greater than 20 years and annualized total return of 23% during those years. That is only 1% less annualized return than Warren Buffett. Solomon is predicting 2012 to be a good year and appears to be excited with their pipeline of drugs and acquisitions.
The company has steady repurchased their shares since 2004, reducing outstanding shares by approximately 25%.
Valuation/Metrics and Good Financial Statements:
One of the first things that jump out is the favorable metrics of Enterprise Value to Ebit (EV/EBIT) and Enterprise Value to Free Cash Flow (EV/FCF).
Enterprise Value: 6,766
Ebit (TTM): 1432
FCF (five-year avg.): 1107
EV/EBIT = 4.72
EV/FCF = 6.11
The GuruFocus Discounted Cash Flow indicates an intrinsic value of $76, which matches similar valuation methods I’ve produced, including discounted earnings, discounted book, etc. The numbers appear to range from $70-$90. Even, the low range provides us with a comfortable 50% margin of safety.
Average Return on Total Capital (10 years) = 20.9%
Average Return on Equity (10 years) = 20.9%
The company appears to be cheap and cheap in relation to several of its competitors and has a considerable margin of safety. The management is recognized as being among the very best.
Disclosure: I have no position, but may initiate one within the next 72 hours.
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