TARO - Taro Pharmaceutical Industries Ltd. Is An Overlooked Opportunity

2023-12-12 06:07:01 ET

Summary

• Taro Pharmaceutical Industries is a hidden treasure in the pharmaceutical industry, with a Strong Buy Quant Rating and positive financials.
• The company has been overshadowed by Teva Pharmaceutical Industries but has potential for growth in its niche.
• Taro's recent earnings report showed increased sales and profitability, making it an attractive investment opportunity.

Hidden Treasure

Taro Pharmaceutical Industries Ltd. (TARO) is a lightly traded, Israel-based pharmaceutical firm. Taro specializes in researching and developing healthcare products and sells ingredients to other pharma companies. We believe Taro stock deserves a Buy assessment after considering its risks/rewards. Seeking Alpha's Quant Rating is a Strong Buy with top A grades for valuation, growth, profitability, and momentum.

Taro has been a hidden treasure living in the shadow of Teva Pharmaceutical Industries Ltd (TEVA), also an Israel-based pharma company. Taro's market cap is $1.42B, whereas TEVA tops $11B. Financial media publish nearly 10 articles each week about TEVA. On a good week, Taro logs one article a week. Nearly all the articles lately about both companies are positive. The average volume of TEVA shares traded is about 8.7M. Taro's average volume is 28,536.

After the value of Israel-based stocks dived following the terrorist invasion and massacre on October 7, Israel's economy was predicted to suffer. A pall was cast over vibrant investment opportunities like Taro. Israel's GDP was on track to grow by 3.2%; the latest forecast is for 2.5% growth in 2023. Share prices of publicly traded companies fell on average at first ~14%. Shortly afterward, we alerted investors that Israel's economy is resilient and will withstand the war well. Israel-based stocks will recover, and portfolios will prosper over time. The downturn is an opportunity.

The hardest hit stocks are agriculture growers and food purveyors, manufacturing, and banking. 15% of the workforce is now drafted into the defense of the country cutting into production and earnings. Israel's food imports are hindered as is the domestic expansion of 5G . But Israel-based firms with international business and sites overseas in tech and pharma are on our Buy and Strong Buy list for consideration.

Profile and Earnings

R&D is the cornerstone of Taro in its production and worldwide sales of over 200 off-patent generic and over-the-counter tablets, capsules, suspensions, solutions, creams, and ointments. Taro synthesizes active ingredients used in many of its key products and sells those wholesale.

From 2008 through 2023, Taro was set to be taken over by an India-based pharma company. In May '23, BusinessLine reported the pursuer was offering $38 per ordinary share for the remaining 15% of outstanding shares. As of August '23, shareholders were still holding out for a higher price.

There is no word yet about any deal striking this year, but Taro's Q2 '23 earnings announcement in October was better than we expected . That might encourage a better per-share offer. For the quarter ending September 30, 2023 compared to September 30, 2022

• Net sales of $148.2M increased, in part, due to a one-time gross-to-net ("GTN") adjustment. Excluding this, sales increased but only in mid-single-digits.

• Gross profit jumped to $73.6M or 49.7% of net sales compared to $47M or 36.0% of net sales Y/Y.

• Research and development (R&D) expenses rose $2.8M to $14.3M due to increased clinical studies.

• SMG&A expenses were up to $54.5M, including takeover talk expenses. Excluding these charges, SMG&A was $48.4M compared to $42.3M Y/Y.

• Operating income was $4.7M including a one-time charge; operating income was $10.9M compared to operating loss of $6.8M in the same quarter the previous year.

• Net income was $8.5M compared to a net loss of $2.8M, resulting in an EPS of $0.23 compared to an EPS loss of $0.07

• Net income for 6 months was $18.6M compared to $11.3M Y/Y, resulting in an EPS for 6 months of $0.49 compared to $0.30 for 6 months in 2022.

• Net cash provided by operations for the six months ended September 30, 2023, was $55.3M versus net cash used in operations of $37.7M for the 6 months ending September 30, 2022.

• As of September 30, 2023, cash and cash equivalents, short-term bank deposits, and marketable securities increased $40.2M to $1.3B from March 31, 2023.

S A assessed a Hold Quant Rating to Taro Pharmaceuticals for 9 out of 12 months in 2023. News and numbers in May, November, and December elicited a Strong Buy rating. S A's Factor Grades are lofty over the last 6 months:

Risks/Rewards

The long battle to finalize the takeover of Taro and take it private is going to require more time and money on the part of Sun Pharma. In July, Krensavage Asset Management, Taro's largest minority shareholder, told the press the $38 offer "is paltry," and "amounts to a 17 percent discount to the value of Taro's tangible assets, namely $36 a share of net cash." If they want to liquidate Taro and take it private "shareholders could receive more than $45 a share."

Moreover, the offer "seemingly ignores Taro's 22 generic drugs awaiting clearance in the U.S. including (in July) four with tentative approvals." The 2024 consensus has the EPS for the FY ending in March 2024 to be about $1.38 if the company controls its SMG&A and can limit spending on fighting the takeover. We expect Taro to announce its next earnings report on January 23, 2024.

There is a significant risk that if the deal is not effectuated the share price can drop like when Intel ( INTC ) walked away from Tower Semiconductor ( TSEM ). The stock price collapsed.

Taro's short interest, as of now, is less than 2% suggesting that investors are not worried. Taro's PE is over 34, but by comparison, the average PE ratio of European pharmaceutical companies tops 60, and healthcare companies have a PE ratio of 44.

Taro does not pay a dividend and the ROI over the last 90 days has been next to 0. Asset growth is stymied at 0.58% because of the takeover stalemate. Hedge funds sold over 248K shares last quarter following a 30.48% share price increase YTD and +25.67% over the last 12 months. Over the last 5 years, the number of hedge funds owning shares fell from 15 to 4 in Q2 '23; by the end of Q3 '23, the number of hedge funds owning shares was to 9 resulting in a high grade for momentum.

Takeaway

Analysts of the Mumbai-based Sun Pharmaceutical Industries are bullish on the stock. They forecast good financial growth for the company coupled with Sun's commitment to expanding its pipeline of products. In the case of Taro Pharmaceuticals, it all depends on what Sun or others are willing to pay after the share price has climbed this year. The company has little to no debt and holds over $900M in cash.

We doubt the stock will move closer to $45 on its own over the next 6 months but it might inch closer if the takeover is negotiated or earnings beat estimates. In our opinion, retail investors with a high-risk tolerance and confidence in the Strong Buy Quant Rating might profit from a 10% to 15% rise in the share price once the war against Hamas wanes. Israel and India have friendly diplomatic and business relations.

On its own, the current share price deserves its high valuation Factor Grades for Enterprise Value, Price-to-Sales, Price-to-Book and to Cash Flow , and Cash-to-Debt. Taro has been overlooked and now, to paraphrase, Mark Twain, opportunity is the time to take a chance.

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