Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
With its shares down 13% over the last 12 months, 2017 has not been kind to Allergan (AGN) stock -- and now, It looks like things may be starting to get even worse. This morning, analysts at Argus Research sounded a warning note on Allergan's growth prospects and downgraded the stock from buy to hold.
Here are three things you need to know.
1. The crux of the issue
According to Argus, sales of Allergan's two key products -- wringle-erasing Botox and dry-eye treatment Restasis -- "are facing heightened risk" from competing products that will be coming to market over the next few years. In particular, Revance Therapeutics (RVNC -5.20%) has a new botulinum toxin-based product dubbed RT002 that is doing well in phase 3 clinical trials. Argus notes that RT002 is proving itself effective at eliminating facial wrinkles for as long as six months per dose -- 50% longer than Allergan's Botox. Argus believes Revance could bring this new product to market as early as 2020, at which point it would begin stealing market share from Botox, and stealing revenue from Allergan.
At the same time, Argus highlights a risk to Allergan's Restasis franchise. TheFly.com reports the analyst is pointing to a recent court decision invalidating four key Allergan patents protecting Restasis. Argus believes that this court decision opens the door to competition from generic analogues of Restasis -- perhaps as early as the middle of next year.
2. Why this is important to Allergan
How big of a deal is this for Allergan? A bit of data from S&P Global Market Intelligence may help to illustrate the scale of this problem. According to S&P Global, Allergan's U.S. specialized therapeutics division (which encompasses both Botox and Restasis) accounts for nearly 40% of Allergan's annual revenue. At an operating profit margin north of 72%, it's 10 percentage points more profitable per dollar of revenue than the company's even larger U.S. general medicine division. USST produces more than $4.2 billion in annual profits for Allergan -- more profit than USGM, despite the latter being a bigger revenue producer.
Translation: Each dollar of incremental revenue lost to USST will have a disproportionate impact on Allergan's profitability.
3. Um, what is this "profitability" that you speak of?
At this point it's probably worth saying a word or two about Allergan's profitability -- or lack thereof. According to S&P Global data, Allergan is not currently profitable. Nor has it been profitable in three of the past five years. Nor do analysts expect Allergan to regain profitability before 2019 at the earliest.
That's kind of surprising considering the huge operating profit margin discussed above, but the reason for this is that when Allergan reports division-level operating profit, it separates out a lot of the costs incurred in generating these profits. Last year, for example, USST reported operating profits of $4.2 billion and USGM reported $3.7 billion. But all of this was before deducting $1.5 billion in "corporate" costs, $2.6 billion in "research and development" costs, and $6.5 billion in "unallocated amortization" -- after which Allergan was left with an operating (and a net) loss for the company as a whole.
Final note: The future for Allergan
Given Allergan's perennial lack of profitability despite selling what appear, at first glance, to be such high-margin "aesthetic" products, you may not even feel you need Argus's say-so to conclude that Allergan stock is one to avoid. But just in case you're not yet convinced, consider this:
One apparently strong bull argument in favor of buying Allergan is the fact that, although GAAP unprofitable, Allergan does at least generate a decent chunk of free cash flow -- $3.4 billion over the past 12 months. The fact that the stock trades for a market capitalization of just 16.4 times this free cash flow, and that it's predicted, by most analysts, to grow its profits at an average rate of 9% annually over the next five years may incline some investors to believe that Allergan stock could be worth buying in hopes it will grow into its valuation.
But here's the thing: If Argus is right, and new products from generic-drug makers and from Revance are going to begin hitting the market by the middle of next year and 2020, respectively, then these threaten to derail growth Allergan's prospects well before the next five years are up. If these drugs do arrive as expected, and if Allergan's growth rate suffers as a result, then Allergan stock may soon look even more overvalued than it already does.