Endo International Plc (ENDP) has been inching higher since September 25 after an agreement with Novavax (NVAX) to provide manufacturing services in its U.S. based facilities for the biotech company’s COVID-19 vaccine candidate.
Given that Endo’s share price has fallen from the $90 level in 2016 to single digits this year with investors suffering from a painful downside along the way, some will understandably be reticent to bet their hard-earned cash on the stock.
For this reason, it is important to check the real investment opportunities, away from the hype caused through association with high-profile biotech names.
I start by providing investors with the reason for which there was an upside in the stock price.
A fill-finish play
Firstly, Novavax, the biotechnology company is deeply involved in a key study for a potential COVID-19 vaccine with its candidate, NVX-CoV2373.
Now, under the terms of the agreement, Par Pharmaceuticals, an operating company of Endo will fill finish the NVX-CoV2373 vaccines intended to be used in Phase 3 clinical trials.
Exploring further, fill-finish manufacturing essentially means aseptically (under sterile conditions) filling of biological drugs in vials (glass containers) for ease of transportation to hospitals or points of care from where they will be administered to test subjects.
Now, since bio-pharmaceutical products are sensitive by nature, they are highly prone to contamination and degradation during the filling up process into glass containers.
Degradation could lead to huge economic losses for the drug developers like Novavax and this is the reason that fill and finish under sterile conditions has to be performed by specialists like Endo to prevent contamination.
Looking further down the road, after the clinical trials, there is an opportunity for a commercial contract covering the U.S. market but an agreement is conditional to the FDA’s approval of the Phase 3 trials.
Moreover, looking at the broader picture, according to the Milken Institute, there are 212 vaccine trials that are currently under development at various phases. Out of these, there are about ten trials undergoing phase 3 trials and others at earlier stages in the vaccine development process implying an eventual requirement for sterile processing too.
This demand should come from small biotech companies that do not have the manufacturing capability of the likes of Pfizer (PFE). As a result, these smaller developers have to resort to contracting out of the fill-finish process.
Looking at the strategic perspective, according to a survey by Market and Markets Research, contract manufacturing due to increasing outsourcing of fill-finish manufacturing processes from small-sized biopharmaceutical companies will grow from $7.5 billion in 2020 to $12.1 billion by 2025, at a CAGR of 10.0% during the forecast period.
Figure 2: Fill-finish manufacturing with Europe leading
Source: Market and Markets Research
However, a closer look at the key market players reveals that the majority are from Europe including the U.K., with North America being only in second position.
This is further confirmed by screening for the top companies.
Thinking aloud, with individual countries having to boost local production because of COVID-led supply chain concerns, there should be additional demand for fill-finish manufacturing within the U.S. resulting in windfall gains for the likes of Endo with a plant in Rochester, Michigan.
Moreover, with the pressure for a COVID vaccine for each individual being felt all over the world, this could mean funding from state actors as the shift turns towards vaccines manufacturing.
To support my statement, there was the executive order signed on August 6 by the president aimed at production of essential medicines, medical equipment and protective gear in the U.S.
According to trade adviser Peter Navarro, speaking at the time of the signature:
We are dangerously overdependent on foreign nations.”
Figure 3: Key market players including the top companies in fill-finish manufacturing.
Source: Market and Markets Research
With the authority’s favoring bringing back pharmaceutical and medical supply chains back home, the groundwork for expansion of manufacturing facilities in the U.S. are here.
Moreover, the growing presence of a larger number of well-established biopharmaceutical companies with potential COVID cures has spurred the demand for fill-finish manufacturing.
Therefore, Endo while not being a large fill-finish manufacturer has already started to benefit from an upsurge in demand with that agreement with Novavax.
However, there is no exact time frame as to when commercial-level demand will materialize. Also, the company has other revenue segments.
Also, it is important to check financial strength and outlook for investors.
Finances, challenges, and opportunities
Second quarter revenues of $688 million decreased 2% compared to Q2-2019. The reason was primarily due to a decrease in the branded segment’s revenues resulting from a reduction in physicians’ practice activity and less patient visits. Both of these were due to confinement and social distancing measures resulting from COVID-19 pandemic.
This shortfall in revenues was offset to a large extent by sales growth in the Sterile Injectables segment as a result of channel customers purchasing and stocking of Vasostrict, in anticipation of treating certain patients infected with COVID-19.
Figure 4: Segment sales for the second quarter in 2019 and 2020.
Source: Seeking Alpha
As for the bottom-line, the company has provided both GAAP and non-GAAP figures for the evolution of earnings from Q2-2019 to Q2-2020. The results using both accounting standards show an increase in earnings.
The reasons for the increase were favorable product mix, lower operating expenses, and some exceptional expenses incurred in Q2-2019 not being the case in the second quarter of 2020.
Also, as for guidance going into the third quarter and H2-2020, the executives are cautiously optimistic.
Figure 5: Q3-2020 and FY-2020 guidance from continued operations
Source: Seeking Alpha
Going into the details, revenue for Q3-2020 will be impacted by significant impact from channel de-stocking (reducing inventory by stocking less). As a result, total 2020 revenue will be less (by a high single-digit percentage as per estimates by the management) compared to 2019.
Additionally, adverse impact from COVID on sales of branded pharmaceuticals as well as delay of new product launches impacting sales of generic drugs are also expected.
The executives also envisage generics to be impacted by competition.
Looking deeper, ENDO generates more revenues from generics than branded drugs. Now, the generic drug segment forms part of a highly competitive market as it not only competes with the original drug but also with the growing number of FDA-allowed copies (authorized generics) manufactured by other companies as they hit the market.
Figure 6: Net revenues and adjusted income from continuing operations on a segmental basis.
Source: SEC filings
This is the reason that new generic drugs must be launched rapidly to beat the competition.
In terms of figures, the impact of launches being delayed has been estimated to be about $70 million for the second quarter of 2020 and the risks going forward is that sales may further be impacted due to second and third waves of coronavirus occurring in the U.S. and Europe.
On a more positive note, according to the executives, the expected declines from pharmaceuticals (branded and generics) are expected to be partially offset by expected growth in the Sterile Injectables segment for H2-2020.
In this context, Endo has a number of drugs undergoing clinical trials, one of them being Xiaflex. The latter is a prescription medicine used to treat adult men with Peyronie’s disease and is currently sold in more than 20 countries around the world.
It is also further being developed as part of clinical trials for plantar fibromatosis.
Figure 7: Ongoing clinical trials
Source: Seeking Alpha
More important is the Phase I label expansion PK study on plasma clearance of Vasopressin in healthy volunteers. The study is progressing, and final results are expected in the fourth quarter of this year.
Vasopressin is indicated for prevention and treatment of postoperative abdominal distention.
Therefore, I have painted a mixed picture with COVID impacting revenues as well as creating opportunities.
Valuations and key takeaways
In order to get an indication of the valuations, it is important to compare Endo not only with other pharmaceuticals but also with healthcare equipment plays like Becton, Dickinson (BDX) due to the nature of operations.
In this context, Endo generates only 46% of total sales from the Sterile Injectables but this segment accounts for 70% of the company’s income.
Figure 8: Comparison with peers.
Source: Seeking Alpha
Exploring further, this is the only segment out of the company’s three where there was an increase both in revenues and gross margins for both the first two quarters of 2020.
Looking inside, this segment boasts the highly profitable Vasostrict which is further being developed to treat other conditions and thus the executives expect longer term profitability.
However, this high profitability will be slightly subdued from pricing pressures for another one of its Sterile Injectables segment’s product called Adrenalin.
Still, when compared with peers, Endo’s overall high gross profits of nearly 50% and revenue per employee of $918K point to some differentiated product and manufacturing capability.
Now, for risk-averse investors, I look deeper at the debt level.
The British company has a Long-Term Debt to Total Capital ratio standing at 108 and a net debt to adjusted EBITDA leverage ratio of approximately 4.5 times.
On further verification, I found that the reason for the high debt is related to mesh legal expenses of $260 million and opioid-related legal expenses of $80 million for the fiscal year 2020.
Still, the current ratio of 2.20 means that current assets are more than two times current liabilities.
Moreover, Endo ended Q2-2020 with approximately $1.8 billion of unrestricted cash.
Also, taking into consideration the company’s diversified offering, the trailing Price to Sales ratio looks to be on the lower side pointing to a lower valuation.
However, in view of the stock price action following news of the agreement with Novavax in September, the stock has already undergone a 24% upside.
Figure 9: Comparison of stock price evolution
Now, in absence of another catalyst, just like during the period following the earnings beat in August, there may be a downside to the $2.85-$3.05 levels constituting an opportunity to trade the stock.
In this respect, for traders, one key catalyst to watch is the launch of Qwo, an FDA-approved treatment for women with cellulite during the spring of 2021.
As for long-term value investors, with a P/E (FWD) of only 1.76, Endo deserves an inclusion in one’s portfolio but some may find it better to wait till the Q3-2020 earnings call for an indication as to the degree to which the Sterile Injectables segment is able to offset revenue shortfalls from pharmaceuticals.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.