Over the past several weeks, the world's best value investors have been filing 13Fs with the SEC, which detail positions held by their respective funds. These reports only contain equity holdings and are backward-looking, so they are not a complete picture of what all these investors own. Regardless, they are still a fascinating insight into what some of the best value investors in the world currently like.
One company that attracted more investor attention than most over last quarter is pharmaceutical company Allergan PLC (AGN, Financial).
Buying Allergan
Over the past 12 months, as the company's shares have declined to new lows, value investors like Seth Klarman (Trades, Portfolio), Wallace Weitz (Trades, Portfolio) and David Tepper (Trades, Portfolio) have all built sizable positions. Last quarter, Klarman's Baupost group increased its position in the business by 52% to 4.5 million shares, which means this stake now accounts for 7.3% of the overall equity portfolio. Tepper's Appaloosa Management also increased its holding by more than 80% to 3.5 million shares, accounting for 6.5% of his overall equity portfolio.
The question is, should you follow these highly successful value investors into Allergan, or is it worth avoiding the business?
Trying to guess why guru investors bought into a position is always tricky, and there is never a definite answer. The same is true with Allergan. This year, the company is facing an enormous challenge as one of its best-selling products, Restasis, is coming off patent, which means it has to fight generic producers for sales. Management has not been able to calculate how much of an impact this will have on the overall business, which means Wall Street analysts are cautious about the earnings outlook. Indeed, since the beginning of 2016, Wall Street's 2018 earnings target for the company has declined from $20.3 per share to $15.4.
The big question surrounding the company now is whether or not 2018 will be a trough year. Management has been working hard to try and reignite sales growth. It seems this is what Klarman and Tepper are betting on.
The company has already taken action by announcing job cuts. It plans to cut over 1,000 jobs and eliminate an additional 400 currently open positions, with the estimated cost savings being around $300 million to $400 million per year.
At the same time, it is investing in the development of new treatments. This year, Allergan is expected to continue to develop a new migraine treatment, ubrogepant, which has the edge over competitors’ products due to the fact it is swallowed, not injected.
But at the same time, the company’s underlying business continues to tick along. The Botox business is still performing well and an anti-psychotic drug, Vraylar, has blockbuster potential. Botox sales jumped nearly 17% to $864 million in the fourth quarter, above consensus estimates of $778 million, according to Thomson Reuters. In comparison, sales of Restasis rose nearly 1% to $415 million.
A value play
Looking at these numbers, it is possible the sales decline facing Allergan is not as bad as many investors and analysts fear. Yes, Restasis faces pressure, but there is still a substantial underlying business attached, and there’s room for sales upside if the pipeline pays off.
With this being the case, the stock’s valuation of 10.2 times forward earnings looks cheap, especially when you compare it to the rest of the sector trading at 15.6 times forward earnings. This valuation does not appear to give any scope for future earnings surprises; if Allergan performs better than expected, the upside could be substantial. Put simply, this looks to be a very traditional value play.
Disclosure: The author owns no stocks mentioned.
