"When the facts change, I change my mind. What do you do, sir?"
- John Maynard Keynes
I sold all my holdings in Allergan plc (AGN) this morning after deciding to eliminate my entire position in the name.
In addition, I took the stock off of my Best Ideas List ($184.58). This step leaves me with 20 shorts and only five longs on the list. (Allergan is a holding of Jim Cramer's Action Alerts PLUS charitable trust, which continues to stick by the stock.)
I have reached this conclusion with some reluctance after carefully perusing the company's earnings release, listening to Allergan's conference call and the decision not to break up the company, acknowledging a modest reset lower of 2018-19 expectations, reflecting upon the controversial deal with the Saint Regis Mohawk tribe giving the group the patent rights to one of the company's key drugs, and watching CEO Brent Saunders' interview on "Mad Money."
I believe there may be more vulnerability to Allergan's 2018-19 outlook than suggested by management or believed by analysts. Relatedly, for those still interested in Teva Pharmaceutical Industries (TEVA) -- a company that had a bad miss this morning and is a stock I would avoid -- Allergan plans to sell its Teva investment in an "orderly fashion." The shares have been previously marked down by AGN but are likely to be marked down further in light of recent results.
Allergan reported modest (and expected) third-quarter revenue, earnings and cash flow beats and the shares rose by nearly $8 yesterday after falling briefly to under $170 a share early in Wednesday's session. Allergan addressed the competitive challenges to Restasis, which contributes about $2.15 to earnings per share with 80% contributing margins, forecast mid-single-digit revenue growth for its core businesses and underscored that it is committed to its current portfolio and that a breakup of the company is not on the table at this time. Allergan faces more than $2.3 billion of near-term loss of exclusivity (LOEs) with Restasis, Estrace, Namenda XR and others, and as a result next year's earnings per share will "rebase" slightly lower as those patent expirations begin to impact results.
Only A Modest 2018-19 EPS "Reset," But ...
Management forecast more than $15 a share in 2018 EPS, though the consensus was $17.60 a month ago and is now $16.85, assuming mid-2018 introduction of a generic entry of Restasis, and for fiscal 2019 the company sees results better than 2017, which currently are estimated at about $16.20 a share. As I wrote, this will force a modest "reset" of sell-side estimates and, in time, a likely reduction in their too-ambitious price targets.
As recently as three weeks ago, JPMorgan delivered reduced 2018-20 EPS estimates for Allergan, which now once again seem too high, of $17.29, $18.47 and $21.17, respectively:
"Full year, JPM is at the midpoint of consensus for Allergan (at $16.18 a share). For 2018 JPMorgan is using $17.29 (revised slightly -$0.40 lower from previous estimates because of lower share repurchases). For 2019 $18.47 seems achievable and in 2020 they have a point estimate of $21.17 (down about $0.90 from their previous forecast)."
--Kass Diary, "Allergan Update"
After yesterday's lower earnings reset, management expects mid-single-digit core sales growth and with new drug launches and share buybacks, expects to produce low double-digit EPS growth. There now appears almost no chance for upward revisions in 2018-19 EPS. Indeed, the odds of a further EPS reduction over the course of the next few quarters seems heightened given the timing of generic competition and several developing legal issues.
I no longer am willing to wait out the next 12 to 24 months of relatively flat and uninspiring earnings. My prior reduced price target of $250, expressed a month ago, now appears too optimistic and is likely to be closer to $200, providing an unattractive reward vs. risk.
Admittedly, while the shares at 12 to 13 times earnings appear inexpensive relative to company forecasts, biotech investors are selective. They seek growth, not stability of profits, and are an impatient lot, as we have witnessed in the recent meltdown in Celgene Corp. (CELG) from $145 to $100 and in the June, 2015 to May, 2017, drop in Gilead Sciences Inc.'s (GILD) share value from $115 to $65.
The notion of "value," I have observed, occurs at far lower prices than many expect in the sometimes-volatile biotech space.
I believe the U.S. stock market is overvalued and, accordingly, I must have a compelling reason and a positive reward vs. risk (upside vs. downside) to justify the retention of a stock.
I started 2017 in the belief that Allergan would be among the best performing large-cap stocks that I follow/own, available at a low relative and absolute valuation with a more-than-reasonable upside to consensus profit forecasts. For some time this view proved correct. The shares rallied from about $190 to over $260 (I made a large sale in the high $240s), only to fall back down after repeated drug patent disappointments.
Since then, there have been disappointments relative to expectations at Allergan.
Given the earnings reset discussed above and the lack of EPS upside over the next two years, there is no longer a compelling case to hold the shares of Allergan (upside vs. downside is uninspiring) as an extended period of flat to lower EPS likely now faces the company.
In light of the above it seemed prudent for me to jettison the shares today.
(This commentary originally appeared on Real Money Pro at 9:03 a.m. ET on Nov. 2, and has been updated for the author's trading transactions. Click here to learn about this dynamic market information service for active traders.)