Elanco Animal Health (ELAN -1.21%) has been trading on the markets for less than two years, and on Feb. 19, the company reported its first full-year results since it separated from Eli Lilly (LLY 2.10%).
The stock has a more modest market cap of $12 billion compared to Lilly's mammoth $136 billion valuation. But a lower valuation doesn't necessarily make Elanco a better investment, as it'll have to prove to investors that its growth opportunities are strong enough to make it a good buy. Let's take a look at where the company is today and whether investors should consider buying shares of the animal health company.
Elanco's recent earnings results were unimpressive
In the company's fourth-quarter results, the numbers were simply not impressive. Elanco reported a 2% decline in its top line with revenue of $787 million, down from $799 million in the prior-year quarter. The company finished the quarter in the red with a net loss of $9.5 million, which compared negatively to the previous year. However, in 2018, Elanco benefited from an income-tax benefit of $18.6 million which propped up its bottom line in Q4, pushing it into the black with a total profit of $16.4 million.
For the full year, Elanco recorded a profit of $67.9 million on revenue of $3.07 billion, for a net margin of 2.2%. In the prior year, Elanco's margin was slightly higher at 2.8% of revenue.
Is there enough growth for investors?
With no growth in the top or bottom lines, investors wonder if there will be any improvements in future quarters. In the company's earnings release, Elanco reaffirmed the guidance for the 2020 fiscal year that it gave in January, saying it still expects revenue to fall between $3.05 billion and $3.11 billion.
However, that guidance means at best, sales growth will be just 1.3%, and at worst it will be another year of sliding sales. And with margins very small, that's likely not going to translate into much growth in earnings per share, either. The one saving grace is that Elanco could become a much bigger company, very soon.
In August, Elanco acquired the veterinary drugs unit of Bayer (BAYN -0.07%) for $7.6 billion in a cash-and-stock deal. The move would make Elanco one of the largest manufacturers of medicine for pets. According to researchers, the animal health industry is worth $44 billion and is expected to grow at an annual rate between 5% and 6%.
Elanco expects the deal to accelerate the company's growth, and that by the third year, it will generate operating cash flow of close to $1 billion. It also expects the deal to achieve synergies totaling between $275 million and $300 million.
Is Elanco overpriced?
Currently, Elanco is trading at a forward price-to-earnings ratio of 26. Given the stock's lack of growth, it's a hefty price tag for investors to pay today. Even if we look further ahead and factor in its expected five-year earnings growth, by using the price-to-earnings-growth ratio, the stock still trades at a fairly high PEG of around three (growth investors typically look for a multiple of around one or less).
In 2019, shares of Elanco fell 6.6% while the Health Care Select Sector SPDR Fund rose 18%. Even with the decline, the stock is still a bit of an expensive buy.
Investors should pass, for now
Elanco doesn't offer investors any attractive reason to hold the stock today. While the deal with Bayer may pay off over the long term, investors may be better off waiting to see what the company's updated numbers look like once the two are fully integrated. Elanco expects the deal to close in mid-2020.
Without a dividend, there's not even an incentive for investors to hang on and wait. And lackluster earnings results thus far will ensure that the healthcare stock isn't going to have a much better year in 2020 than it did in 2019.