Finding stocks that look undervalued is great, but sometimes shares of companies look cheap because the market has little faith in their prospects. And sometimes, the market happens to be correct. Of course, investors need to do their due diligence before making a final decision. Still, the point is that low valuation metrics alone aren't a conclusive reason to buy a stock.
With that in mind, let's look at a healthcare company that is about as cheap as it gets right now: generic drug manufacturer Viatris (VTRS 0.51%). Currently, this company boasts a forward price-to-earnings (P/E) ratio of 3.8 and a forward price-to-sales (P/S) of 0.9. For context, the average forward P/E of the pharma industry is 12.4, while a P/S ratio less than one is generally considered attractive. So is this stock worth buying at current levels?
The new kid in town, with a rich history
Viatris is a relatively new company that started trading on Nov. 17, 2020. The entity was formed when pharma giant Pfizer spun off its off-patent medicine unit Upjohn, which merged with the company formerly known as Mylan. The transaction seems to have benefited both Pfizer and Mylan.
The former got rid of a business that had become a dead weight on its bottom line due to several medicines whose sales were declining. Meanwhile, Mylan, a company that was already in the generic drug manufacturing business, expanded its portfolio of drugs and its footprints across the globe by teaming up with Upjohn.
The challenges of the generic drug industry
Generic drug manufacturers can make a lot of money by introducing generic versions of blockbuster products marketed by other pharmaceutical companies. This business model highlights the importance of patents for drugmakers. Bringing a new molecular entity to market is capital intensive as it requires companies to jump through clinical and regulatory hoops.
If it weren't for patent protection, these companies would have little incentive to go through all these troubles since competitors can often reverse-engineer new molecular entities. Once patent exclusivity expires, though, it allows companies like Viatris to introduce cheaper generic versions, thereby stealing some market share away.
The problem Viatris faces is that other generic drug makers can (and often do) make generic versions of the same medicine it is targeting. Without patent protection for these exchangeable products, Viatris has little competitive advantage. With that said, the company boasts something north of an impressive 2,100 products in more than 35 markets worldwide, making it one of the largest players in the industry.
Further, Viatris owns reliable brands that will likely remain somewhat popular for the foreseeable future. These include Viagra, Lyrica, and Xanax, among others. Consumers tend to gravitate toward those products they are familiar with, which can help confer Viatris some degree of customer loyalty.
What does the future hold for Viatris?
Viatris is one of the leaders in many markets worldwide, including the U.S. and some parts of Europe. It also has a rich pipeline of products in addition to its already robust lineup of popular brands. About 75% of the company's pipeline includes complex generics and biosimilars, which are generally harder to produce and therefore face less competition on the market.
These newer products will help Viatris navigate one of the most significant shortcomings of its business model. At the same time, the drugmaker is looking to improve its balance sheet, which had nearly $20 billion in long-term debt as of the end of the third quarter. Viatris pledged to pay down $6.5 billion in debt by the end of 2023.
True, the company's current results don't look too impressive. In Q3, Viatris recorded net sales of $4.5 billion, which represented a decrease of 4% compared to the year-ago period, considering that Mylan had already teamed up with Upjohn in Q3 of 2020. Viatris also reported net earnings of $311.5 million, which is hard for investors to compare to the year-ago period without estimates of its net income in Q3 2020 had the merger with Upjohn not happened, which the company did not provide.
Still, investors should appreciate Viatris' commitment to reducing its debt while looking to launch a raft of competitive products in the coming years. Further, the company currently offers an above-average dividend yield of 2.30%, together with a conservative cash payout ratio of 14.9%. Management is committed to dividend increases, too, making the company an interesting option for income-seeking investors.
Overall, Viatris is a company that is unlikely to outperform the broader market, despite its low valuation metrics. But for investors looking for a company with a stable business and a solid dividend, it is worth purchasing shares of this healthcare stock.