Australia | Jun 28 2006
By Greg Peel
When the Mayne Group split into Symbion (SYB) and Mayne Pharma (MYP), brokers were indifferent towards the former but initially quite keen on the latter. Since then it’s been a rollercoaster ride as the world has come to terms with the competitive generic drugs market and the surrounding regulatory nuances, legal battles, and general health market considerations.
Along the way few stocks have split the market as significantly as Mayne Pharma. At any given time since its birth in November brokers have simultaneously rated it a screaming Buy and a screaming Sell. A lot of the flip-flopping of ratings can also be contributed to the stock yo-yoing its way through life.
After a May-June round of analyst reports, we have reached some sort of stand-off. In other words, nearly every broker in the FN Arena database is sitting on Hold (it would be unfair to say this is the place to be when you’ve given up). There are, however, two Buy recommendations – one is Merrill Lynch, but on the basis that the stock was sold off too hard.
The other is JP Morgan. The analysts have not wavered from their Overweight call since initiating coverage after the split. With each successive report, one gets the impression the analysts have been banging their heads against a brick wall.
A continuing beef with consensus valuation is that there has been no premium included for the potential synergies associated with in-licensing and M&A. There is still upside here, the analysts insist.
The latest bee in the bonnet relates to fixed cost leverage. When the analysts compared their ongoing earnings forecasts with the market, they found that with each successive year the divergence grew larger. They are 4% ahead of consensus for FY06, 12% for FY07, 27% for FY08 and 32% for FY09. It all comes down to fixed cost leverage.
The analysts took the time to go and check out Mulgrave manufacturing and distribution centre and found that there was excess capacity due to efficiency improvements. They learnt that the Boulder facility offered the same. The conclusion was that "a reasonable portion" of all the generic drugs in the pipeline could be accommodated within existing facilities.
Morgans also believe Mayne already boasts an experienced generic sales force, and that new drugs emerging from the pipeline would not require an increase in sales head count.
The last point concerns pricing dynamics of generics. The analysts note the greatest margin on a new drug is achieved in the first two years. As 40% of revenue is added from drug launches over the next three years, they expect margins to increase. The only threat to this is margin decline in mature products, but the analysts point out that mature product sales have increased, not decreased.
Morgans suggests the market will slowly wake up to the fixed cost leverage factor, and Mayne will be re-rated over time. The analysts’ own valuations do not include an acquisition element, so further upside exists. Earnings growth forecasts are 22% in FY06, 40% in FY07 and 13% in FY08.
Mayne closed yesterday at $2.55. The average target price in the FN Arena database is $3.03, or 19% upside, but five brokers recommend Hold. Morgans’ target (included in the average) is $3.50, and has been since the stock listed. This represents a more optimistic 37%. Morgans continues to rate Mayne Pharma as Overweight.