From a headline standpoint, Allergan plc (NYSE:AGN) stock does look attractive at the moment. A steady pullback has seen Allergan stock fall about 35% from late July highs and Allergan has dropped by half from 2015 levels.
The downward moves have left AGN looking particularly cheap. A sub-10x forward EPS multiple is notably cheaper than those assigned to rivals like Pfizer Inc. (NYSE:PFE) and Merck & Co., Inc. (NYSE:MRK). And it has led to investors arguing that Allergan stock is simply too cheap.
In fact, I made that case back in December, calling AGN stock one of 10 2017 losers that would perform better in 2018. That hasn’t been the case, as Allergan stock actually has dropped about 3% so far this year.
Upon further reflection, and even with AGN slightly cheaper, I’m not nearly as confident in Allergan as I was just five months ago. AGN is cheap, and there is a case here for some upside here. Yet as pressures mount, there’s also echoes of past pharmaceutical stories in AGN stock – and the risk of a major loss keeps me on the sidelines for now when it comes to Allergan.
Real Concerns Surrounding Allergan Stock
This isn’t a case where the market has simply dumped AGN without paying attention. There are real risks here. Earnings growth is likely to turn negative in 2018, with the company guiding for EPS of $15.25-$16.00 against 2017’s $16.35.
Competition is rising. Allergan itself framed its 2018 guidance as dependent on generic competition to eye treatment RESTASIS. Allergan had tried to deny generic competition by transferring its patent to the Saint Regis Mohawk Tribe. That effort, however, hasn’t worked. And now Imprimis Pharmaceuticals Inc (NASDAQ:IMMY) has launched a 99-cent competitor.
Meanwhile, Allergan’s highly profitable Botox treatment may also see a new rival. This month, Chris Lau detailed the efforts of Revance Therapeutics Inc (NASDAQ:RVNC), which is working with Mylan NV (NASDAQ:MYL) to launch a biosimilar. All told, some 20% of revenue is at competitive risk in the coming years.
Add to those fears some questions about the company’s pipeline, and an overall lack of confidence in the drug development space, and there is some logic behind the long, hard fall in Allergan. And with a reasonably substantial debt load – over $23 billion on a net basis, about 3x EBITDA – any further downward pressure on valuation would be amplified in the AGN stock price.
It’s not as if industry leaders are priced for torrid growth: PFE and MRK trade at 12x and 13.5x forward EPS, respectively. Given that Allergan has a heavier debt load, declining near-term earnings, and material competitive risks, a discount to those titans doesn’t seem wholly out of line.
The Bull Case for AGN
All that said, there is a case that the decline has been too much. On the Q4 conference call Allergan cited a solid pipeline in eye care, which could replace all of the lost revenue from RESTASIS competition.
Botox has significant brand value, and Barron’s cited a portfolio manager who pointed out that consumers “might be uncomfortable testing a new product” given that Botox is a toxin injected into the patient’s face.
As for valuation, AGN might merit some discount to PFE & MRK – but even a discounted 11x multiple still suggests modest earnings decline going forward and values AGN stock at $172 – over 7% upside from current levels.
And with the company itself guided for a 5% increase in revenue long-term, after a bit of a ‘reset’ year in 2018, even a modest multiple combined with some level of earnings growth could create nice returns in Allergan stock.
To be honest, I am sympathetic to that case. In fact, it’s basically the argument I made in December. But I’m no longer sure that AGN is worth the risk, and I’m particularly skeptical there’s reason to jump in now, ahead of Q1 earnings next week.
AGN Stock Looks A Little Too Risky
All told, I wouldn’t be shocked if Allergan stock managed to grind higher from here. But I question whether the upside necessarily is worth the downside risk.
After all, the pharmaceutical space is very different from what it was a decade or two ago. Efforts to control pricing and increase generic competition have taken a toll. MRK and PFE have been decent investments.
But the market has seen outright collapses in Valeant Pharmaceuticals Intl Inc (NYSE:VRX), Teva Pharmaceutical Industries Ltd (ADR) ADR (NYSE:TEVA), and Mallinckrodt PLC (NYSE:MNK).
I’m not arguing that Allergan stock is the next VRX or MNK. For one, its debt levels are nowhere near as high. But investors thought those stocks were “too cheap” all the way down as well, and I’d be worried that a similar, if less disastrous, fate might await Allergan. When growth slows for an indebted company, the stock price can fall far and quick.
When that company is a pharmaceutical company, and investors start questioning the pipeline, it takes a long time to reverse that sentiment.
That’s what has happened at Allergan of late – and I’m not confident enough that the worst is over just yet. And for what looks like only reasonable upside, I’m not interested in taking on that risk.
As of this writing, Vince Martin has no positions in any securities mentioned.
