ELAN - Elanco Animal Health: Seems Like A Decent Bet Right Now

2023-07-25 13:21:59 ET

Summary

• Elanco Animal Health Incorporated's share price has declined by 43% over the past year, but the company's raised guidance for 2023 suggests potential for investors.
• The company has recently been granted a conditional license for the first Canine Parvovirus Monoclonal Antibody, which could significantly boost revenue.
• Despite challenges such as supply disruptions and softening dispensing trends, Elanco is growing its margins and has a large market to serve, with pet spending rising over 10% YoY between 2021 and 2022.

Investment Outline

Elanco Animal Health Incorporated (ELAN) has as the name suggests niched itself towards pricing services and products for pets and farm animals. The share price has been in a steady decline for the last 12 months, down around 43%. Perhaps coming from a high valuation before, the p/e now is at 14.

But with a beat reported in May on both the top and bottom line in the quarter, there seems to be some good potential here for an investor. Margins look solid too and the raised guidance that the management provides in Q1 suggests that 2023 will generate $4.4 billion in revenues on the higher end. An EPS of $0.83 and a multiple similar to the sector of 16 would mean that there is some short-term upside here. If the Q2 report on August 7 , 2023, surprises then I believe we will see the current downwards trend for the share price reverse. I find the risk/reward ratio here to be very favorable but some improvements are needed before a buy seems realistic.

Company Overview

Operating as an animal health company in the United States, it offers various services related to animal insurance. Besides that, they also offer pet health disease prevention products like vaccines and parasiticides. These services help improve the health of pets by protecting them from worms, ticks, or fleas. Elanco has developed a line of brands which has these properties, some of them are Seresto, Advantix, and Advantage.

Pet health is the focus for Elanco but they have been active in developing their product line like mentioned above here. They have also diversified outside of domesticated pets and offer services for commercial farming space. Here they have vaccines, antibiotics, and nutritional supplements to aid in animal health.

Recent Developments

Back in May of 2023 , ELAN released that they have reached a breakthrough in terms of treatment for the deadly canine parvovirus. The USDA has provided ELAN with a conditional license for the first Canine Parvovirus Monoclonal Antibody. This marks the first and only approved therapeutic solution that is proven to treat canine parvovirus.

The estimated amount of treatments out there right now in the US is 330.000 annually. That is a massive market to serve and should be a significant revenue tailwind for ELAN going forward. The CEO Jeff Simmons had some comments to share on the announcement, "We're excited to bring our first monoclonal antibody treatment to market, reinforcing Elanco's commitment to pioneer new tools in spaces where there aren't existing options".

Apart from the release of this very positive news, on May 9, 2023, ELAN also posted its Q1 report . Total revenues amounted to $1.257 billion, an increase of 3% YoY. But there is still a massive market for ELAN to serve as in the US 66% of all households have pets, that's 86.9 million homes in total. I expect steady and perhaps not explosive growth for ELAN going forward. But that is also worth a premium, and one slightly higher than what ELAN currently gets. Strengthening this argument is the fact that spending on pets rose by over 10% between 2021 and 2022. Pets are also an investment and growth and spendings are likely to not just be short-lived, in my opinion.

Besides the solid results, ELAN also raised their guidance slightly for 2023, $30 million for the bottom end of revenues. Not large, but a continued optimism about the full year accounts for something in my opinion. With the base business stabilization, ELAN can return to growing margins once again. During 2021 ELAN took a significant hit to its margins , but they have been on a steady path to recover towards what it had in 2019, a net margin of around 4%. Going into Q2 seeing ELAN resting and growing upon margins will be crucial for the investment thesis right now. I think as the Estimated Unwind of ERP Blackout in Q2 happens, more consistent growing reports should be visible.

Margins

Getting back margins for ELAN will be a very important challenge they need to tackle in the coming quarters. It seems that higher selling and general expenses have taken a stab and the bottom line. They rose between 2020 and 2021 by over 30%. This type of increase whilst revenues didn't necessarily outpace it meant that margins didn't improve and when the interest expense came into the picture it became clear that net margins would remain suppressed. As I view it, the coming quarters will tell the story of ELAN's ability to improve margins.

Valuation

Looking above here it displays that perhaps growth needs to be faster before a buy could be considered. The intrinsic value right now sits at $3.5 per share. That does make it such a compelling buy when the share price is sitting at nearly $12 right now. For investors seeing exposure to animal health and companies operating and providing services there, ELAN looks to be a good option. But for those that seek a solid return over the long-term, a return that beats out the market, then ELAN is not at that point right now, I think. I have set a terminal rate for FCF growth of 5%. For the last 5 years it has been 6% annually, but being conservative with estimates often results in better investment, I think.

Risks

Elanco faces several challenges, one of which is the concern over supply disruptions, especially with certain vaccines. If these disruptions persist or worsen, they could not only impact revenue but also affect the company's reputation and relationships with customers. The reliability of the supply chain becomes crucial for Elanco to maintain a steady flow of products and meet market demands.

Additionally, Elanco is cautious about the softening dispensing trends, partly driven by the reimplementation of the MAP policy, leading to higher prices. Balancing profitability and market demand is crucial, as higher prices may cool down consumer demand. Competitors could also seize the opportunity to undercut prices, adding further competitive pressures.

In response to these challenges, Elanco must adopt effective supply chain management strategies, ensuring robust relationships with suppliers and implementing contingency plans to mitigate potential disruptions. I think the company also needs to strike the right balance between pricing strategies and maintaining customer demand, perhaps exploring innovative marketing and product differentiation approaches.

Investor Takeaway

ELAN is growing its margins back to where it used to be in 2019 before the pandemic. The rise of pets during the pandemic has created a massive market that ELAN can serve, and it looks even more appealing when you see that spendings for pets rose over 10% YoY between 2021 and 2022.

The share price has been in a steady decline as the expectations of higher margins seem to be further out than the market anticipated. I find for my hold rating to transform into a buy rating the net margins need to grow faster than they are, and a higher YoY growth for revenues is also necessary. Otherwise, there are better options out there that also provide a dividend. In conclusion, I am rating ELAN a hold right now.

For further details see: