2023-06-14 05:13:59 ET
Summary
- Alkermes is pushing higher in continuation of a near 3-year uptrend.
- Investors continue paying a higher market valuation for the company based on its strong business economics.
- The firm is rotating capital from growth investments into additional market value over time.
- Net-net, reiterate buy.
Investment Summary
The investment thesis for Alkermes plc ( ALKS ) posted in January has somewhat been vindicated with a 15% return at the time of writing. There are several indications to suggest this increase in market value can continue into the future, based on sound, thoughtful analysis of the company's future.
Looking ahead, there are 3 core objectives that, if formed correctly, could be potential strong tailwinds for ALKS:
- Arbitration with Janssen and subsequent royalty stream;
- Growth outlook (sales, earnings); and
- Exceptional economic characteristics of the business, including returns on capital and profitability.
These three factors have resulted in 6 earnings revisions in the last 3 months, and combined with fundamental and valuation factors, support a reinstated buy thesis. The stock has pushed higher in FY'23 in continuation of a longer-term uptrend [Figure 1] and if extended would be a very interesting case. This report will run through the factors underlining the buy thesis, with careful explanation of each point. Net-net, reiterate buy.
Figure 1. ALKS near 3-year rally off 2022 lows– long-term momentum not to be discounted
Data: Updata
Catalysts for price change
The latest ALKS developments reveal numerous inflection points that must be discussed in detail. Chief among these is the arbitration with Janssen around its antipsychotics lines. This was not covered in my last publication and is therefore new data to be considered.
Arbitration with Janssen and Royalties
- Regarding the arbitration with Janssen, the company is involved in a dispute over royalties related to the sales of several long-acting labels within its INVEGA line. These include:
- INVEGA
- SUSTENNA,
- INVEGA
- TRINZA,
- INVEGA
- HAFYERA, and
- CABENUVA
- Each of these are antipsychotic medications and one HIV product. With the court's involvement, a panel of experienced arbitrators issued an interim award, affirming that Janssen had the right to terminate the license agreements with the formulas in question. However, in order not to infringe on ALKS' IP rights, Janssen must pay royalties to ALKS for continuing to sell the products. Naturally, this ruling has favourable implications for the company's financials.
- In my view, the tailwinds that emerge for ALKS are as follows:
- Back royalties and extended royalty terms . The first investment implication I'd draw from this content is the potential positive impact on the company's revenue stream. As per the 2nd interim award, the company is due back royalties of approximately $194mm for 2022.
- Additionally, the panel agreed with ALKS' position that the royalty term for INVEGA TRINZA and INVEGA HAFYERA extends beyond 2024, all the way through Q2 of 2030.
- This represents an additional 6 years of royalty revenues for these two labels– bake this into your models straight away.
- Moreover, the award stipulates that royalties for CABENUVA in the U.S. are owed t hrough the end of 2036 . It goes without saying these extended royalty terms provide a long-term revenue stream for the company. The tail of asset returns on all these labels is set to be quite long and therefore profitable for investors going forward, provided ALKS keeps up the footwork with its sales. Talking of predictability of future cash flows, there isn't a more beneficial form of income.
Ancillary benefits, growth outlook
I'd also point out the potentially positive impact the above decision has on ALKS' competitive position in the market. The arbitration ruling solidifies the company's IP rights and ensures that Janssen cannot continue to sell the developed products without paying royalties.
Additional benefits
Hence, it is in the best interest of ALKS for Janssen to move volumes of the competing labels, because it will feed directly to the company as income without having to take on any additional risk. This strengthens the company's competitive advantages at the profitability level (discussed later) by supporting the growth of its proprietary product portfolio.
There's sales data outside of the products in mention to back the claims of growth up as well. LYBALVI came in with Q1 net sales of $38mm, equalling 16% sequential prescription growth. The focus for LYBALVI in FY'23 is centered on 3 critical initiatives: e xpanding prescriber breadth, l everaging the access profile, and b uilding awareness.
Hence, you'd be looking to the entire product portfolio as a measure of ALKS' momentum this year. Looking to the Q1 numbers as a base for this, my takeouts were the following:
- Total revenues clipped $287.6mm underlined by a 25% YoY growth in its proprietary product portfolio.
- As a standout, the VIVITROL segment's net sales were $96.7mm, representing 14% growth, while ARISTADA's net sales increased by 10% to $80.1mm. LYBALVI net sales reached $38mm as mentioned, with a 9% sequential growth.
- Critical to my investment thesis, the company's manufacturing and royalty business recorded revenues of $72.9mm.
On the expense side, it booked quarterly OpEx of $335.7mm, including R&D investment of $117.1mm (which I have chosen to capitalize as an intangible investment on the balance sheet with a straight line amortization schedule) and SG&A expenditures of $191.2mm. It pulled this to a net loss of $57.8mm for the period.
A critical fact in the ALKS investment debate is this: the firm is generating superb returns on the capital it allocates, meaning it can focus on growing the business whilst spinning off cash to its owners.
This is a firm with attractive economic characteristics that goes underneath the hood. The following points must be considered here:
- Consensus projects 98% forward EBITDA growth in FY'23
- ALKS has thrown off an additional $31mm in TTM free cash flow since Q3 2020
- The return on its existing operating capital at risk routinely manages 25-30% on a trailing basis and was 19.2% last quarter
- Post-tax earnings are $174mm less on the reduced size of the business, but on an incremental basis, the company has generated an additional 281% profit growth for its investors over this time
Table 1. ALKS return[s] on incremental capital
Data: Author, ALKS SEC Filings
I believe this is a primary reason why investors have been inclined to pay higher market valuations for the company over time. A company is simply a conduit between its investors (owners) and the assets/equity that underpins the operations. In that vein, the returns on incremental are also the investors returns on capital, and the market is happy when a company shows it can grow capital more effectively than the benchmark.
Growth outlook
Management reiterated FY'23 guidance of $1.25Bn at the upper end of range and my numbers are above this at $1.31Bn for the year. It could pull $1.1Bn gross and $313mm adj. EBIT in this with my growth assumptions. All going well, it would spin off $293mm in free cash to shareholders, in-line with 2021 levels. This is an attractive number, for the reasons mentioned above– given the firm's ability to invest capital at high rates of return, it can focus on feeding this cash to shareholders whilst staying on the growth course.
Projecting out to the coming 4 years of trade, I believe ALKS could be a $300mm FCF company by FY'24, and discounting these projected cash flows at 12% hurdle rate (long-term market averages) gets me to an equity value of $115, something to heavily consider.
Figure 2. ALKS forward-estimates
Data: Author
Valuation and conclusion
There are critical facts to dissect in the valuation debate too. One, is that investors are selling their ALKS stock at 37x forward earnings and nearly 5x book value. That's an interesting proposal, and investors are paying this– the stock is up above all relevant moving averages from 10–200 days, indicating the strong hands entering the market.
Another thing to ask is what you are getting for that premium, around 90% to the sector at the time of writing. Well, looking at the price-earnings growth ("PEG") ratio, that quantifies the price you're paying scaled by the expected growth you're paying for, a number <1 is better, indicating you are getting bang for your buck on the growth front.
ALKS trades at 0.69x PEG and this tells me there is tremendous earnings growth projected on the horizon, both by the market and consensus, in-line with my own projections above. At the ~0.7x multiple, it appears that any price is being paid for a piece of ALKS growth in the coming 12 months. This is backed by robust fundamental and economic data from the business. At 37x my FY'23 estimates of owner earnings, I get to $65 per share, a reasonable upside on the current market price of 106%. I've run this through a number of scenarios, with each pointing to a favourable outcome; therefore am attracted by these figures.
These findings are also supported objectively by data examined and scrutinized by the quant system. It too has found strengths in ALKS on valuation, growth and profitability, in-line with my own findings, thereby adding a layer of confidence to both. This tells me these are factors to watch out for in this name.
Figure 3. Quant rating, ALKS
Data: Seeking Alpha,
Net-net, the econometric data is clear to my investment cortex that investors are diligently buying ALKS at higher multiples as we progress through the year. This is backed by robust fundamental and company-level data that shows the firm investing at high rates of return– above what I can achieve by riding the benchmark. This is critical in my investment criteria in order to suggest my company will create value down the line. On that, I am looking to $290-295mm in FCF from ALKS this year, and a revised price objective of $65, with eyes on a $115 price target further down the line. Net-net, reiterate buy.
For further details see:
Alkermes: Powering At 280% Return On Incremental Capital Since 2020