Royalty Pharma’s Cash Flow Growth Will Power the Stock Higher

Royalty Pharma (NASDAQ:RPRX) has been fairly flat since its first trade after its IPO in mid-June. For example, RPRX stock opened at $44.00 and closed at $44.50 on its first day of trading. It opened this week strong, but has pulled back to just that debut level.

Image of two scientists in lab coats studying results in a lab
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And while the biotech’s shares have been able to stay far above their $28 IPO price, since then, nobody’s made any real money on the stock.

It is hard to understand this. The company earns royalties on more than 45 commercial biopharmaceutical drugs and three development-stage product candidates. This means it gets paid straight off of the sales figures, before any costs, before the cost of goods sold and before any selling or admin expenses.

By the way, Royalty Pharma does not set the prices of the drugs. It simply collects a percentage of whatever is sold in its portfolio. The company raised over $1.9 billion in its IPO. It used that money to purchase over $1.7 billion of new royalty assets so far this year.

Net Cash Flow Growth Continues

On Aug. 12, the company released its earnings for Q2 showing it produced net cash flow growth of over 33%. In addition, adjusted net cash flow growth was almost 5o%. The company defines adjusted cash flow as EBITDA less research and development expenses.

Adjusted cash flow was $369 million, a 47% increase compared to $250 million for the same period of 2019 on a pro forma basis. So on an annualized basis, this works out to almost $1.5 billion ($1.476 billion).

Since the market capitalization for RPRX stock is $26.65 billion, the adjusted cash flow yield is 8.88%. That is a very high yield. Moreover, if the company keeps on growing its cash flow by 47% every year, you can expect in three years that cash flow will be up by 217.7%. It will be at $1.172 billion per quarter or $4.688 billion annually.

That implies that at this growth rate, the company’s cash flow yield will be 28.2% annually. If so, there is simply no way that RPRX stock will stay at its present price.

For example, even if the stock grew by two-thirds of this 47% growth rate in its adjusted cash flow, it will rise by 88.4% from today’s price. It will hit $85.53 by then.

So, the point is that at the growth rate the company is presently experiencing, RPRX stock is not going to stay flat for very much longer.

What to do with RPRX Stock

Barron’s wrote a glowing review of the stock when it came public. But sell-side analysts do not seem to be very excited about the stock.

For example, J.P. Morgan has a “neutral” rating with a $50 target price. Morgan Stanley has the stock rated as “equal-weight.” But SunTrust RH has a “buy” with a $56 target price. That represents a potential 23% gain over today’s price.

As Barron’s points out, this company provides a good for society. Almost 75% of all drugs in the U.S. and Europe come from America’s academic and biotech research complex. This IPO gave the company more money to put into this system.

But as I have suggested, the company’s cash flow growth rate will provide more dry powder to fund more biopharmaceuticals. So investors in this stock get the same benefit that they would as investing in a drug stock.

I believe that RPRX stock has a bright future. Its high cash flow yield and its associated growth bring a high probability that the stock will rise. I have shown that it could rise by at least 88% over the next three years. This assumes that the same high growth rate in its cash flow continues over that period.

Even if it doesn’t and grows at a slower pace, the stock’s high cash flow yield is an indication that it is still deeply undervalued.

Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks. Subscribers receive a two-week free trial. As of this writing, Mark did not own any of the aforementioned stocks.

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