In the animal health industry, one company in particular acts like a wolf on the prowl. Elanco Animal Health (ELAN 1.41%) is the world's second-largest animal health company and specializes in pharmaceuticals. The company spun off from pharmaceutical giant Eli Lilly in 2018 and has gone through a dramatic transformation since leaving its parent.
One of the most significant changes Elanco announced was its acquisition of Bayer Animal Health in 2019. The acquisition was completed in August 2020 and catapulted Elanco to the forefront of the animal health industry. Now that the merger is complete, what can investors expect the combined company to do in 2021?
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A $7 billion pet healthcare acquisition
The merger with Bayer was transformational but came at a steep price. Elanco paid $5.2 billion in cash and issued 72.9 million in shares to Bayer. This makes it one of the most expensive deals in the animal healthcare industry's history.
Elanco pursued the Bayer merger for two key reasons. The first is that historically, Elanco has been focused on supplying the livestock animal healthcare market, but wanted to expand its reach into the faster-growing pet healthcare market. Bayer Animal Health generated a majority of its revenue from the pet market and brought to Elanco a drug pipeline and notable industry blockbusters including Seresto and Claro.
The deal is also expected to produce significant cost synergies which will enhance the combined company's earnings growth rate. The headline number is $300 million in synergies driven by manufacturing and production efficiencies as well as a more streamlined research and development and salesforce organization.
The combined company has already started its efforts to realize the cost synergies and expand its global presence. 2021 will be the first full year of operation for the new Elanco.
Margin expansion ahead
One of Elanco's main messages to investors is that the company has a clear path forward in regards to its growth and profitability. However, there are still some hurdles along the way. Elanco is still working to fully transition off of Eli Lilly's management systems. Now the company must also deal with achieving the cost synergies from the Bayer acquisition. Despite this, Elanco is confident that moving forward the company's performance will greatly improve.
Over the next few years, Elanco expects to reach 60% gross margin from 51.8% gross margin in 2020. This will be driven by achieving greater scale from increased unit volumes and a restructuring of the company's R&D, salesforce, and manufacturing.
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These margin enhancement initiatives are also expected to lift Elanco's EBITDA margin. EBITDA stands for earnings before interest taxes, depreciation, and amortization and is a measure of earnings. The company has a long-term target of 31% and expects EBITDA to grow at a double-digit rate in the coming years. This is a significant improvement over its current level but notably still markedly less than its main competitor, Zoetis.
In 2021, Elanco is targeting an adjusted EBITDA of just over $1 billion leading to a 22% margin. This is almost double the $528 million of adjusted EBITDA that Elanco reported in 2020. If Elanco can achieve these earnings growth targets, shareholders would likely rejoice.
Is Elanco a buy?
Elanco has recently caught the eye of investors and its stock is trading at its highest level in more than one year. Clearly, investors are excited about the prospects of the combined company and the earnings potential.
2021 will be a pivotal year for Elanco as it will be the first full year operating as a combined company with Bayer. The company has put out ambitious earnings targets and investors will be paying attention to whether or not the company can execute on its stated goals.
