John Paulson (Trades, Portfolio) has 60% of his assets in the Healthcare sector. Of that, his largest holding, Akorn Inc. (AKRX, Financial), makes up 2.68% of his total assets, an 8,974,400-share stake good for a 7.17% position in the company, which he’s held since the low $30 range.
This bet on health care includes other trades that have lost a lot of value like Valeant (VRX, Financial), Gilead (GILD, Financial), Teva (TEVA, Financial), Mylan (MYL, Financial) and Allergan (AGN, Financial). In fact, it was a pretty bad year for health care stocks in 2016; however, the industry’s sales and profits continue to grow.
Aside from Gilead, Akorn is one of Paulson’s most undervalued holdings. It’s an excellent generic drugmaker even though the specialty pharmaceuticals industry will continue to see turbulence due to increasing customer buying power, rising competition from a shrinking Food and Drug Administration (FDA) backlog, fewer drugs coming off patent and regulatory issues with some generic firms. I know that just sounded like your run-of-the-mill TV ad that starts out with benefits and ends with a ton of side effects and disclaimer language, but let’s dive into the company and stock.
First, since 2006 Akorn has produced solid growth for investors, growing revenue from $71 million to over $1.1 billion and turning its earnings around from a net loss of $6 million to a net gain of $185 million in the last 12 months. In fact, that’s up 22% from the prior year thanks in large part to the company’s ability to diversify its portfolio of drugs while harvesting a strong pipeline with 92 filings pending with the FDA addressing $9.2 billion of market potential. This financial growth has helped the firm build its book value from 73 cents per share to over $6.47 per share without excessive CapEx spending, which remains well below 50% of total net income.
Historically, to remain competitive in health care you have to continue to spend money on research and development (R&D), but as primarily a generic drug company, that expense is far lower for Akron. It spent just $39 million in the last 12 months on R&D. What really matters is the company’s management. Can it pick winners and successfully market them?
Since taking over in 2009, Akorn CEO Raj Rai has transformed the company. It went from being a small, overly diversified, unprofitable company into a niche generic manufacturer that pounds out cash. Analysts predict drug consolidation and increased competition yet Akron has used acquisitions to increase scale and concentration in highly profitable areas like injectables, ophthalmology and topical creams where barriers to entry are higher because of complexities in manufacturing and regulatory restrictions. Injectables and ophthalmology drugs, for instance, require sterile manufacturing processes, which means higher investments upfront, many of which new entrants will not readily be able to make. Also, topicals and nasal sprays generally have more complicated formulas, making them harder to replicate. All good news for Akron.
Valuation
The company will likely be unable to grow tenfold in the next decade; however, at its current price multiple, FDA filing pipeline and a return on equity rate of 26% the stock is at a level that could warrant a long-term investment. The stock is down 43% in the last six months and still on track to generate $2.25 per share for fiscal 2016. A price adjustment may not be imminent, but at 15 times earnings of $2.25, we’re looking at a $33 number. Paulson is holding for a reason.
Disclosure: I have no positions in any of the stock mentioned in this article.
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