2023-04-14 14:31:14 ET
Summary
- BioMarin presents with attractive business economics that warrants a constructive view.
- The firm's revenue ramp looks steep and this could pull through to strong owner earnings to drive value for shareholders.
- My numbers point to attractive economic profits from the firm's growth in the next 3 years.
- Net-net, we rate it a buy at $138–$195 valuation range.
Investment summary
Despite undergoing a sharp consolidation since my last publication , I still see immense value in BioMarin Pharmaceutical Inc. (BMRN) over the coming periods. When I covered the name in February it was priced at $115 and has clipped a 14% correction to trade at $98 at the time of writing. Two reasons I'd put forward for the market activity:
- The 41% rally had extended for around 12 months by the time of my last publication, meaning longs could sell and collect profits without incurring short-term capital gains tax. This is very common for extended rallies that last for ~12 months or more, resulting in short-term, albeit sharp corrections.
- A broader rotation out of defensive healthcare names and back into the FAANG's of the world, corroborated by the 7% gain in the SPX since early March, spurred on by shifting interest rate differentials and other macroeconomic inputs.
Nevertheless, my stance on BMRN remains unchanged and following its FY'22 numbers the investment case is even stronger in my opinion. I believe BMRN can grow top-line revenues by ~16.5% this year and generate $860mm in adjusted net operating profit after tax ("NOPAT"), and throw off $564mm in cash to equity holders. Management also estimate 15% EPS growth this year at the mid-point with an increase in demand across all product lines. Further, my numbers estimate the company to create tremendous economic profit and value for shareholders into the years to come. Organic growth in its key product lines, coupled with strategic investments into growth at delicious rates of return, underpin this thesis as you'll see here today.
The stock trades at 22x my FY'22 earnings estimates of $836mm but I believe this is majorly undervalued as I value BMRN at ~37x forward earnings or $165 per share, offering an attractive 4.5% earnings yield at the current market price. Consequently I am drawn to the value proposition on offer with BMRN and reiterate my buy rating from February.
Fig. 1
Growth catalysts to drive valuation upside
My analysis seeks to point out that numerous inflection points must be considered in the BMRN investment debate. In particular, there is high probability the firm will generate attractive growth in its core operations to feed income down the bottom-line to shareholders.
One, BMRN's FY'22 numbers adequately position the company to spring forward with product sales volumes this year. It booked $2.1Bn in top-line revenues last year, a 13.5% YoY growth rate on a 33% EBIT margin when adjusting for R&D. I firmly believe that we should treat BMRN's R&D as an intangible investment that should be capitalized, rather than treat it as an operating expense as is required under GAAP accounting rules. It is not required to maintain business operations, rather is dedicated to generate additional economic value to the firm. This gives a far cleaner view of what BMRN actually did and can do below the top-line.
The contribution from BMRN's product lines is worth mentioning. Its enzyme brands alone provide a $1.6Bn foundation for additional Voxzogo and potential Roctavian markets. Management guides for $330-$380mm in Voxzogo revenues for FY'23 - 100% YoY growth, and as of January ~1,265 additional children with achondroplasia [stunted growth from skeletal dysplasia] were receiving treatment from the compound. It is in 32 markets as well, indicating the uptake. This, after the FDA expanded its label to children under 5 and gained market share. Yet, only 6% of the total addressable market currently receiving treatment with Voxzogo to date so the upside potential is still huge in this regard. It also sees $255mm in Palynziq turnover and Roctavian revenues of $100-$200mm.
I had opined last time about the Roctavian opportunity. Around 300+ patients have been contacted about Roctavian, the firm's treatment for Haemophilia A. It's noted these patients will be on direct follow-up on Roctavian's launch. Further, management advised it has secured a major reimbursement payer in Germany to cover treatment. Two key points here, however:
- The bureaucratic process of obtaining the German payer has stalled the route to market for Roctavian. Mainly due to finalizing agreements with insurance purveyors.
- It is completing this whilst pursuing a federal reimbursement agreement. This is said to take around 1 year in total.
- In extension, management reports it is growing BRMN's insurance network in Germany, and that current organizations cover "essentially 100% of the German population".
Two, another important point to consider related to Roctavian. Ten patients, all in Germany, have gone through ARUP Laboratories' companion diagnostic test - a blood test, designed to be used with Roctavian, that is filters patients most likely to respond to AAV5-based gene therapy. Management have said that around 20-35% fail the screening criteria, depending on geography. However, because it has the insurance contracts signed and enforceable, that's what facilitated the uptake in this combination so far. That's important - because prescribers are likely using the test to confirm a prescription to Roctavian. It's worth noting that Kuvan revenues are forecast to continue dwindling due to generic competitors in the U.S. and Europe, forecast at $125mm for the year. From hereon in, the company will not be providing annual Kuvan guidance.
Three, with 16.5% growth in revenue baked into my projections BMRN could do $2.44Bn in turnover this year and $1Bn in adjusted EBITDA with the R&D investment at ~33% of sales. I'd see this pulling to $$875mm in less depreciation and ~$860mm after tax. With the lift in sales enormous operating leverage is a major expectation:
- The extra $345mm in revenue could turn operating income at 53.8% YoY year growth to $70mm reported, 25% YoY to $875mm adjusted for R&D.
- The resulting margin of $2.44Bn would therefore be 2.9%, around 70bps liftoff from the year prior. Hence, I believe the operating leverage will generate large efficiencies in generating cash flow into the future.
Four, accounts receivable increased by $62mm YoY to $461mm with the lift in revenue, hence cash collection was lower. It paid an additional $59mm to accounts payable, which stood at $231mm. Combined, this led to a large pullback in cash generated from operations ($175mm) after it bulked up inventory by another $68mm. This is not a concern for me for a number of reasons. Firstly, the cash collection into this year will likely pick up speed as those orders come through to CFFO. Secondly, given the operating leverage discussed above, I estimate BMRN will only need an additional $14mm in NWC requirements and additional $18mm in CapEx to hit its growth numbers. These two factors combined will positively impact free cash to shareholders. Finally, the ramp sales will be a large benefactor to generate more cash sales.
Benefits to shareholders from discussed growth points
This next section is incredibly important in forming my investment thesis for BMRN. It's one thing to observe BMRN's growth numbers + estimates, but it's equally as important to know how it's going to play out. For the company, it will sell more product units, and increase the profit per unit. But this will come at a cost. It will need to invest more cash to hit these marks. Investing in biotech and pharma requires niche investments into tangible and intangible assets. BMRN will need to purchase additional manufacturing and lab equipment, refurbish its facilities to keep up with production, purchase additional land, and keep up additional constructions. Moreover, it will invest in clinical studies and R&D.
Attractive business economics
Since FY'18 to date, the additional NOPAT BMRN has generated on these kind of investments has been commendable. Here, R&D investments are capitalized as an intangible with a straight line amortization over 7 years (in-line with BMRN's numbers). The calculus shows BMRN has routinely generated a c.20% rate of return with a 22% return on invested capital ("ROIC") in FY'22. Collectively, it generated an incremental 71% ROIC since FY'18 after growing NOPAT by $777mm in 5 years, an average $155mm over the 5 years. In FY'23, in my downside case BMRN will have to reinvest 62.5% of earnings into capital, in my upside, 16.5%. Looking ahead to the coming 3 years, my numbers point to the following:
- BMRN to invest an additional $1.56Bn in capital towards growth investments. It would have $4.7Bn in capital and NWC requirements to maintain that level of operations.
- My numbers point to BMRN hitting these same ~20% ROIC numbers over this time frame as well.
- Collectively, it's not unreasonable for BMRN to hit incremental ROIC of 17.1% from FY'23-25, and reinvesting ~57% of its post-tax earnings back into the business to grow. This would still throw off a large amount to shareholders in my estimation.
- When factoring a $537mm estimated investment this year [including R&D, and potential goodwill adjustments - I penalize companies for their goodwill in calculating returns on capital] then adjusting for goodwill I believe the cash investment will be $294mm. At c.$860mm in NOPAT projected that could throw off ~$564mm in free cash flow attributable to shareholders after the firm takes 16.5% to reinvest the following year (upside case) or $168mm in FCF with a 62.5% reinvestment (downside case).
As far as valuations go, this is the kind of business economics that intelligent investors are attracted too.
Fig. 2
Fig. 3
Future value creation for shareholders
I've mentioned the uptick in demand across BMRN's portfolio combined with potential conversions from its pipeline. I'd like to demonstrate how I envision this to generate value for investors, in quantifiable terms. As mentioned, I forecast strong organic sales and operating profit growth ahead driven by demand and product uptake. That could pull down to strong cash earnings for the firm's owners, coupled with ~20% return on the capital reinvested to grow the business. Exactly how efficient, and effective is this to wind up free cash flows however?
Consider the following:
- Looking from FY'19 to its latest set of numbers, capital intensity reduced overall as invested capital turnover has improved from 0.57x to ~0.7x. This tells me capital is generating more turnover per unit invested, exactly what we want to see when the firm is investing more in further capital to grow the business.
- Exactly to this - as capital requirements increase, not only to maintain but grow operations, this may impact profitability. This hasn't occurred for BMRN, and I look to the firm maintaining a c.30% NOPAT margin into FY'25.
- The strong capital efficiency/invested capital turnover means BMRN doesn't have to rely entirely on pricing strategy in order to generate profitability, as it can still achieve ~20% ROIC with a pullback in NOPAT margin.
- Most importantly, however, the firm needs to continue generating a return on its capital above the cost of capital to create shareholder value. Such has been the case to date, when adjusting for R&D. Looking ahead, my numbers anticipate ~18% economic profit for shareholders (ROIC less WACC hurdle). Without the R&D adjustment, it turns to negative 4%, meaning BMRN's R&D is worth ~14 percentage points to the company's, and investor's profitability.
- Hence, more capital efficiency, at higher rates of investment return, feeding more cash to shareholders, whilst still investing to grow. This is the ideal setup for valuation upside in my opinion.
The important part is this: The economic profitability means each unit of growth BMRN generates over this forecast period would be of value to shareholders. Ultimately, we'd expect more owner earnings to accommodate this. Therefore, I believe BMRN will trade at higher multiples and this supports my buy thesis.
Hence, my conclusions on BRMA's valuation are as follows [see: Appendix 1-3]:
- Discounting the stream of cash flows to owners forecast into FY'28 at a 5.5% discount rate [current WACC hurdle + 1% risk premium] values the stock at $138-$195, or a $25.6Bn-$36.2Bn market cap.
- On my FY'23 estimates the market has BMRN valued at 8.5x-22x forward earnings. I believe this is offensively low. My numbers point to a valuation of 22-43x forward earnings, 160% off the market's value.
- Adjusting the discount rate to 6% accommodate execution risk from the Roctavian launch sees it valued at $118 (downside case) to $165 (upside case), a tasty bite of upside to sink my teeth into.
Therefore, the risk reward calculus from my valuation estimates are further evidence required to bolster the buy thesis. If my projections in the upside case are correct, there's tremendous upside on the table for investors.
Fig. 4
Data: Author, BMRA 10-K's
Fig. 5
Data: Author, BMRA 10-K's
In short
Demand for BMRN's portfolio combined with its attractive business economics underpin my buy thesis. Specifically, I see double-digit topline growth into the coming 3 years and this to be backed with outstanding profitability to throw off huge piles of cash to shareholders. It's important to remember that all of my calculations treat R&D as an intangible investment, amortized in a straight line over 7 years. I don't believe it will be sales growth alone, however. Given BMRN's track record, my numbers suggest it can generate strong returns on the growth capital it invests. Net-net, I see it fairly valued at $138-$195 in my downside/upside scenarios.
Appendix 1. Upside case estimates [16.5% reinvestment of post-tax earnings required for maintenance and growth capital].
Appendix 2. 10-year projections [NOTE: Cash flows for valuation are only discounted from FY'28, as seen in Appendix 1].
Appendix 3. Downside case estimates [62.5% reinvestment of post-tax earnings required for maintenance and growth capital].
For further details see:
BioMarin: Growth Could Come With Tremendous Profit Potential