UTHR - United Therapeutics: Incremental Profitability Gains Justify Premium

Summary

• The market has swiftly priced in United Therapeutics Corporation's patent dispute.
• The company exhibits strong profitability momentum, with growth coming in at a low cost to earnings.
• It, therefore, feeds a high percentages of residual free cash flows to shareholders.
• Net-net, we rate United Therapeutics Corporation a buy at 17x earnings.

Investment Summary

We've continued to increase exposure to names exhibiting profitability momentum in FY23'. We are on the lookout for companies with high ROIC that exceeds the higher cost of capital. Given the heavy re-rating of high-beta, unprofitable names, this has proven to be a rewarding trade to date. On this front, we rate United Therapeutics Corporation ( UTHR ) as a long-term buy given its cohesion to this investment thesis.

We like United Therapeutics Corporation thanks to: 1) its clinical trial momentum in various phase 3 assets; 2) the market swiftly pricing in the outcome from Liquidia ( LQDA ) patent invalidation swiftly priced in by the market; 3) sequential growth pattern leading into FY22' earnings; 4) profitability momentum with high incremental ROIC; and 5) high residual cash flow from post-tax earnings distributable to equity holders. Each of these are supported in Seeking Alpha's quant grading [Exhibit 1a]. Looking at our 12-month performance from this kind of analysis, we believe UTHR is well-positioned to re-rate higher with a strong earnings print later this month.

Exhibit 1. UHTR price evolution, momentum continues with pullback to long-term support

Exhibit 1a. UTHR Factor Grades

LQD patent dispute swiftly priced in

Unfortunate for UTHR, a U.S. patent court denied the company's request for a rehearing of its patent invalidation decision in July last year against LQDA, concerning the company's '793 patent. This followed the hearing that commenced in October FY21' regarding UTHR's Tyvaso. In July, the court found in favor of LQDA and ruled that UTHR's patent had been shown to be unpatentable. It subsequently denied UTHR's request for a rehearing, as mentioned, meaning the decision is upheld.

Fortunately for UTHR, however, is that the market looks to have swiftly discounted this, and the subsequent price response has been relatively mild. Moreover, UTHR is likely to appeal the decision, and this is likely to delay LQDA's competing label. This is likely to be recognized by the market, and we look to corresponding price action following UHTR's FY22 results.

Mid-term growth drivers

UTHR presented at the JPMorgan 41st Annual Healthcare Conference , where it outlined its intended growth levers for the coming periods. Trial momentum in its Tyvaso label, combined with its Ralinepag segment, both gathered robust data for treating patients with pulmonary hypertension ("PH"). It hopes to deliver geometric growth from these segments, with potential crossover of both labels into pulmonary fibrosis ("PF"), where it quoted the growth opportunity is hoped "to more than double current revenue with [PF]". Hence, we are looking at UTHR to deliver mid-term growth percentages through these segments, and feel the market hasn't fully recognized this potential. Language on its FY22' earnings call is, therefore, paramount to gauge this further.

Exhibit 2.

Along with this future growth profile, it expects a cash OpEx spend of <50% of FY21' revenue. We are data-driven investors, thus, searching deeper at this level is where we see the value in UTHR. Looking at UTHR's P&L, inspecting rolling TTM periods from Q1 FY20' to Q3 FY22, we noted the company generated nearly $6Bn in NOPAT on an additional growth of $241mm, with just $1.1Bn in capital investment [Exhibit 3]. Subsequently the return on incremental invested capital ("ROIIC") pulls into ~22%, securing a 4% geometric company growth rate over this time [Exhibit 4].

Regarding our investment thesis, the market rewards this setup, because a firm increases its valuation by generating high ROIC above the hurdle rate, where the growth comes cheaply to equity holders. Only 18% of post-tax earnings were required to invest in UTHR's future growth, leaving ~82% as residual cash distributable to equity holders - hence the 24% CAGR in its stock price since January FY21' [inclusive of Q1 that year].

Exhibit 3.

Exhibit 4. UTHR 18% NOPAT reinvestment for 22% incremental ROIC

Valuation and conclusion

With the returns on capital and tidy reinvestment rates needed for this future growth, we believe there's scope for the stock to rate higher. Assuming it can retain this profile, we see it valued fairly at ~17x trailing P/E. It currently trades at ~15x trailing P/E [non-GAAP] and hence the value gap. We assume a cost of equity of ~11% from the growth rate and trailing earnings yield, per Roberts (1991). In this vein, United Therapeutics Corporation stock is undervalued with scope to a potential re-rating to the upside, by estimation.

Exhibit 5. 17.3x fair P/E with growth/reinvestment assumptions

Net-net, we instigate coverage of United Therapeutics Corporation as a buy, citing strong profitability momentum and additional medium-term growth levers it is working to. We look forward to providing additional coverage after United Therapeutics Corporation's FY22' earnings. We are looking to a 17.3x P/E at this stage, with potential for a re-rating after this date. Rate buy.

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