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Buy Allergan

posted on July 29, 2015 at 9:11 pm
yuan & abacus

Allergan’s (AGN) $40.5 billion sale of its generic drug unit to Teva Pharmaceutical (TEVA) is a clear example of addition by subtraction.

Before the deal Allergan was the third largest global generic drug company, according to Standard & Poor’s, with global generic sales of $6.5 billion. With generics accounting for 73% of sales, Allergan is clearly going to be a very different company after the deal.

But what, exactly?

Well, the combination of Allergan’s cornerstone Botox franchise and the recent acquisition of Kythera Biopharmaceuticals for $2.1 billion gives some clues. Botox, a neurotoxin, is a key drug in the growing aesthetics market. Medically Botox is injected in small amounts to weaken a muscle in order to reduce spasms. In the aesthetics market, Botox is injected to reduce wrinkles, crow’s feet, frown lines, and other signs of aging. Because manufacturing neurotoxins is a tricky process and because minute differences in neurotoxins can produce radically different results, Allegan has been very successfully in defending Botox’s market share, estimated at 76% globally. Botox revenues are about $2 billion annually.

Kythera’s key product, recently approved by the Food & Drug Administration, is Kybella, an injectable drug for reducing double chins. Like Botox, Kybella provides a non-surgical option in facial aesthetics. It’s an alternative to surgical methods for reducing subcutaneous fat such as liposuction.

Allergan has already started to expand Botox into new applications. For example, Senrebotase, is a derivative of Botox that only affects pain receptors. And I’d expect a similar effort to expand the market for Kybella.

According to Transparency Market Research the facial injectable market had sales of $3.4 billion in 2013 and is projected to grow at a compound annual rate of 14.6% from 2014 to 2020 to $9.4 billon in 2020.

Now there’s no guarantee that Allergan will spend the $34 billion in cash it received as a result of the Teva deal (the rest of the purchase price was in Teva stock) on building up its aesthetics portfolio. It could also go hunting for new high margin generics to supplement the biosimilar business that it retained in the Teva deal.

But the logic of the Kythera acquisition does point Allergan in that direction and so does the valuation of the opportunities in front of the company. The team of executive chairman Paul Bisaro and CEO Brent Saunders showed a laudable (from a shareholder’s perspective) sensitivity to valuations in the timing of the sale of its generic business to Teva. Teva’s earlier bid for fellow generics maker Mylan (MYL) had pushed valuations for generic drug companies to what looked like a peak so Allergan sold to Teva at a top price. That kind of attention to valuation limits the number of big deal candidates that make sense for Allergan. For example, on valuation it wouldn’t make a whole lot of sense for Allergan to buy AbbVie (ABBV), one of the names floating in the rumor mill after the Teva news broke, at a higher multiple and a lower growth rate than Allergan’s own numbers. On that basis Allergan would find smaller deals, such as the one for Kythera, a better fit.

And unless Allergan wants to attract a bid itself from somebody like Pfizer (PFE) is will have to make a number of acquisitions. The cash from the Teva deal is enough to pay off all of Allergan’s debt and fund a buyback program—both of which would make Allergan a very attractive acquisition candidate itself.

As of July 29 I’m adding Allergan to my Jubak Picks portfolio with a target price of $385 a share by January 2016. The shares closed at $337.99 on July 8.

Statoil’s second quarter: Better than the average oil company

posted on July 29, 2015 at 1:16 am
oil_rig_sea

Update: July 28, 2015. Statoil (STO) reported second quarter results today (July 28) that beat consensus estimates on both earnings (NOK3.15 a share vs. the NOK1.62 consensus) and revenue (NOK138.5 billion vs. NOK124.8 billion analyst consensus.)

That doesn’t mean Statoil has found some way to magically sell oil for a higher price than competitors. Second quarter earnings may have exceeded analyst estimates but they still fell 27% year over year.

What’s the secret to the Norwegian oil company’s relative success at a time when oil continues a collapse from $108 a barrel in January 2014 to a July 28 close at $53.15 (for European benchmark Brent crude)?

Statoil’s quarter is a checklist for what an oil company has to do right these days to stand a chance of navigating a plunge in oil prices that still has a while to run. (Statoil is a member of my Jubak Picks portfolio. The position is down 36.4% since I added it on May 10, 2012. )

First, Statoil announced a further cut to its capital-spending budget to $17.5 billion for 2015. That’s down from $20 billion in 2014 and a projected budget of $18 billion reported last quarter. At the same time as the company continued to cut capital spending production climbed with second quarter production, adjusting for asset disposals, up 7% year over year.

Second, Statoil has been able to cut costs—and increase efficiency—so that it is finding and producing more oil even with lower capital spending. Unplanned losses (that is production losses that aren’t the result of planned events such as maintenance but are the result of accidents or weather) have fallen from 12% in 2012 to 5% in 2014. Efforts to increase the percentage of oil recovered from mature and declining off shore fields on the Norwegian Continental Shelf have pushed the recovery factor up to 50% with the company targeting 60% recovery. (Increasing oil recovery is an especially profitable endeavor since the company has already built out necessary infrastructure in the region.) Operating expenses fell an additional 15% quarter to quarter.

Third, Statoil has either been very lucky or very good at finding new oil to diversify its asset base beyond its traditional concentration in the Norwegian Continental Shelf. The company has announced promising finds in the deep-water Gulf of Mexico, off the east coast of Canada, and off both coasts of Africa (Angola and Tanzania.) Statoil has also recently added U.S. shale assets in the Marcellus, Eagle Ford, and Bakken geologies.

All this is backward looking, of course. Looking toward the future, Statoil has potentially lucrative positioning as a major supplier of natural gas to Europe at a time when Western European countries are looking to reduce their emissions of green house gases and to find alternative sources of natural gas to reduce reliance on Russian supplies.

Looking that that same direction, the big uncertainty is whether Statoil can continue to reduce costs and increase production at rates that will enable the company to maintain the current $0.221 quarterly dividend. Right now the company’s payout ratio is running at 80% to 100%, which doesn’t leave Statoil with a huge margin for further drops in the price of oil. In the conference call, the company said that it projects that it can maintain the current dividend payout (for 2015, management said) while reducing the payout ratio. The stock currently yields 5.4%.

As of July 28, looking at the likelihood that oil prices will stay low for a while, I’m cutting my target price to $24 a share by June 2016 from a prior $28 a share. Statoil closed at $16.48 in New York trading on July 28.

Why profit taking in Shanghai turned into panic selling

posted on July 27, 2015 at 1:35 pm
Emerging_Markets

It’s no surprise that China’s Shanghai and Shenzhen stock markets fell over night. After a huge rally on government moves to support share prices, traders—especially traders outside Mainland China–widely expected profit taking. The Shanghai Composite, for example, had climbed 16.1% from July 8 to July 24. That’s so far, so fast that selling seemed inevitable.

But the size of the drop is more than expected. The one-day collapse—8.5% in Shanghai, 7% in Shenzhen, and 7.4% on the ChiNext index—is the biggest one-day retreat since the days of the financial crisis in 2007. Almost 2,250 stocks fell on Monday in Shanghai against just 77 stocks showing gains. More than 1,500 shares in Shanghai and Shenzhen fell by their 10% daily limit.

What seems to have pushed the markets from profit taking to panic?

Rumors that the Chinese government was about to reduce cash support for equity markets. Some traders apparently decided that the China government had targeted 3,800 (or was it a nice round 4,000?) on the Shanghai Composite as sufficient to permit a reduction in government cash available for margin loans. The Shanghai index hit 3970 on July 13 and 4124 on July 23.

A huge increase in pork prices, the most sensitive element in inflation at the consumer level, reinforced fears that the government was about to reduce cash flows into stocks. Between March 20 and July 17, pork prices had surged by more than 20% on a big decrease in hog supply. That had led some analysts to conclude that the People’s Bank of China would look to rein in increases in the money supply in order to prevent inflation, now under control with a 1.3% year over year increase in consumer prices in the first half of 2015, from rising to dangerous levels.

There may also be fundamental—as opposed to speculation about monetary policy—reasons for the drop. Disappointing data on profits at China’s industrial companies sent mainland markets down more than 2% at the open. Industrial profits fell 0.3% year over year in June, the government reported on Monday. That comes after a reported 0.6% gain in industrial profits in May. While that reported increase in industrial profits in May initially buoyed mainland markets, later more skeptical analysis has argued that the increase in May was a result of stock market investments by Chinese companies. Chinese companies routinely invest in stocks and the National Bureau of Statistics has acknowledged that investment gains played a big part in the reported rebound in corporate profits.

Overseas investors have also played a big part, first in arresting the rally off the July 13 bottom and then in casting doubt on the sustainability of government support for stocks. Overseas investors have sold $7.6 billion in shares of Shanghai listed companies since July 6, using the Shanghai/Hong Kong exchange link. Overseas investors pay more attention to measures of valuation than China’s domestic investors and much of the recent selling by overseas investors has been a result of worry about sky-high multiples in Shanghai and Shenzhen.

Also on the international front the International Monetary Fund has, apparently, told the Chinese government that extensive market interventions should be temporary measures and that markets should be allowed to clear through normal market mechanisms, such as price declines. At many times I don’t think Beijing would much care what the IMF recommends but the Chinese government is in the midst of a major effort to win approval for the yuan as a global currency. Reports are that the Chinse government has assured the IMF that market interventions are indeed temporary.

That’s not exactly what traders in Shanghai and Shenzhen who are hoping for more government cash want to hear.

Update Visa

posted on July 24, 2015 at 2:45 pm
supermarket checkout

Updated July 24, 2015.  On July 23 Visa (V) reported fiscal year third quarter earnings of 62 cents a share (excluding one-time items), beating the Wall Street consensus of 58 cents a share. At $3.52 billion revenue for the period was up 11.4% year over year and ahead of Wall Street projections by $160 million.

Shares of Visa climbed 7.1% for the day.

Today, July 24, shares are up again—4.04% as of 2 p.m. New York time—on news that Visa is talking with Visa Europe, which split off from Visa in September 2007, about purchasing its former unit. Visa Europe accounts for 52% of the European credit card market by volume.

As of today, July 24, I’m raising my target price on Visa in my Jubak’s Picks portfolio to $82 a share by December 2015 from the prior target of $78. Shares of Visa are up almost 17% since I added them to this portfolio at $63.65 on November 15, 2014.

Visa’s earnings beat on July 23 was the result of a combination of an increase in transaction volumes and an increase in the fees that Visa collects for the use of its branded cards and transaction system. Nothing like a dominant market position to make a price increase possible. Visa accounts for 50% of all global credit card transactions and 75% of all debit card transactions. Visa makes its money from fees on Visa branded cards and from fees on transactions that pass through the Visa network.

The worry that hangs over Visa in the long-term is that some digital upstart will put together an electronic payment system that will eat into the use of credit cards. That fear receded a good bit when Apple (AAPL) decided that its Apple Pay electronic payment system would work with Visa, MasterCard (MA) and American Express (AXP) rather than compete with those transaction companies.

In its conference call after earnings Visa raised its guidance for earnings growth rate in the fiscal year that ends in September to the mid-teens from the previous low to mid-teens rate.

Lessons from Qualcomm’s earnings debacle for the company, smartphones, and the technology sector

posted on July 24, 2015 at 1:27 am
iPhone_470x225

Let me be honest.

When I recommended selling Qualcomm (QCOM) out of my Jubak’s Picks portfolio on April 2, I wasn’t imagining anything like yesterday’s earnings debacle.

The stock closed at $67.97 on April 2 and I recommended taking profits because valuation looked stressed considering the number of competitors that were putting pressure on margins in Qualcomm’s smartphone chip business. The stock jumped to obey my sell by climbing slightly for the next month or two until it hit $69.86 on June 3. Shares then crept gradually lower until yesterday’s earnings report sent them down to $61.78, a drop of 3.75%.

It’s actually amazing to me that the stock didn’t fall further. For the quarter ended June 30, Qualcomm reported earnings of $1.2 billion, down from $2.2 billion in the year-earlier quarter. Revenue fell 14%. Chip shipments were flat year over year.

And then Qualcomm said things would be worse next quarter, the fourth quarter of Qualcomm’s fiscal year. For the quarter that ends in September Qualcomm projected earnings of 51 cents to 76 cents a share on revenue of $4.7 billion to $5.7 billion. The Wall Street consensus had seen the company earning 95 cents a share on sales of $6.13 billion.

Qualcomm’s quarter and its projections for next quarter highlight a problem across the technology sector. Very few technology companies are making very much money. And those that are can expect to see everybody including my Aunt Tilly chasing them. Qualcomm had averaged better than 20% annual sales growth since 2010 because of its dominance of the market for high-end chips that connect phones to the fastest data networks using the LTE standard. But that dominance has been under attack from companies such as Taiwan’s MediaTek, Korea’s Samsung, Arm Holdings (ARMH), and Intel (INTC). In fact in the first three months of the year Samsung and MediaTek grabbed 19% of the market. The loss of a huge order from Samsung’s smartphone business to Samsung’s chip unit was a major contributor to the end of a 19-quarter string of year over year sales growth at Qualcomm.

I don’t see the dynamic that turned this quarter into such a disappointment for Qualcomm turning around quickly. Qualcomm is predicting rather modest compounded annual growth of mid- to high-single digits in the 3G and 4G-device market over the next five years with average selling price (ASP) of the chips that go into those phones staying flat. That seems optimistic to me given that competition has been driving ASPs lower over the last couple of years, but the view is pessimistic enough to explain why so much of Qualcomm’s reaction to this quarter has focused on cost cutting–$600 million in fiscal 2016 and then an additional $1.1 billion in annual reductions.

The other part of Qualcomm’s response to the challenge of this quarter is to announce that it will be looking to address new markets with management citing networking, mobile computing, Internet of Things, and automotive as adding up to a $10 billion addressable opportunity now with growth to $20 billion by 2020.

I think you can readily see the problem with targeting those opportunities. Lots of competitors are going after the same markets—Cisco and Google (GOOG) in the Internet of Things, for example. Intel is willing to pour billions and then more billions into mobile computing. Apple and Google have both targeted the automotive opportunity.

That doesn’t mean it’s not worth going after these opportunities, but it is important to think about those opportunities in the context of the current pattern in the technology sector of one or two companies dominating a market and collecting all the profits from that market.  Qualcomm cited in its conference call the growing concentration in its own sector. That’s a development that should be familiar to technology investors from the examples of Microsoft (MSFT), Intel, and Cisco Systems (CSCO). According to Qualcomm just two companies—Apple (AAPL) and Samsung account of 85% of the premium smart phone segment. The two companies account for an even bigger percentage of the profits in the smartphone sector: Apple accounts for 92% of profits in the smartphone sector, according to Canaccord Genuity, with Samsung pulling in 15%. The rest of the sector shows a loss—which is how Apple and Samsung can add up to more than 100%.

Looking at these numbers and trends I have to wonder if Qualcomm wouldn’t do a better job for shareholders if it eschewed the short-term solutions being urged on it by activist shareholders and instead concentrated on building an unassailable position in 5G technologies based on its clear lead in 4G technologies. That would produce some short-term pain, undoubtedly, since 5G technology is emerging only slowly. (From a long-term perspective it’s the lag in 5G adoption that accounts for much of Qualcomm’s current disappointment.)

And looking at the Qualcomm story I have to wonder if the pattern of concentrating all the profits in a sector in just a few companies doesn’t go a long way to explaining the number of young technology companies that are concentrating on growing revenue and market share as fast as they can—with the hope that someday that will result in the kind of market dominance that has made Apple such an amazingly profitable company.

Of course, it is a whole lot easier in the current technology market to build a strategy around growing revenue as fast as possible and letting profits take care of themselves somewhere down the road. At least that way a CEO doesn’t flag a profit opportunity and attract lots of competitors.



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