Contrarian investing isn't for everyone. It's emotionally difficult to buy shares of a company that everyone else is ditching as quickly as possible, especially given that it might take years before your contrarian hunch is proven true -- if it ever is. But, for those who can stomach it, contrarianism can provide significant gains to your portfolio.
On that note, there's a contrarian thesis for Viatris (VTRS -0.99%) brewing thanks to its worse-than-expected earnings report for 2021. Shares of this generic drug manufacturer are down by more than 30% in the past month, but it's probable that the market is overreacting to the long-term importance of the recent subpar earnings. And that isn't the only thing making it worth a look, so let's investigate in a bit more detail to see why it might be a great counterintuitive pick.
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What went wrong in 2021
2021 was Viatris' first full year as a unified entity -- a company formed by the spinoff and merger of Pfizer's generic drug division with another generic maker called Mylan. So, it's understandable that things might not be going perfectly smoothly. Combining the operations of two overlapping units implies inefficiencies that might take a while to iron out.
Still, the reason why some investors are dumping the stock is that Viatris' revenue, earnings, and gross margin all shrank slightly over the course of 2021. It brought in $17.8 billion last year, which is actually 1% less than the $18.1 billion from 2020. Likewise, its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) shrank by 6%, hitting $6.4 billion.
Per management's guidance, 2022's figures will be slightly worse, with roughly $17.2 billion in revenue and adjusted EBITDA of only $6 billion. Inflation and mounting competition to produce key, high-margin generics are to blame -- and both are all but guaranteed to persist for the time being.
Then there's the raft of issues which have plagued Viatris since its inception. It isn't profitable, and it also has over $23 billion in debt. Though the company is planning to keep paying down its debt, deleveraging will take quite a long time as 2022's repayments are likely to be only around $2.1 billion.
Why it's a contrarian buy right now
As shown by the above, Viatris has a few problems. But there are a few reasons why it could be a lucrative contrarian purchase.
First, its free cash flow (FCF) is expected to improve this year, rising from $2.5 billion to reach a midpoint guidance of $2.7 billion. That means its flat revenue and earnings growth is unlikely to threaten its ability to meet its financial obligations like debt repayments or paying dividends. Realizing leftover cost synergies from the merger and $600 million in new revenue coming online will likely help the rise in FCF. And realizing even more cost synergies is on the calendar as far out as 2023, too.
Second, on the topic of generating new revenue, Viatris' pipeline is packed with upcoming product launches of generics for popular drugs like Revlimid and Xarelto. And it will be pursuing even more commercialization programs for drugs that have lost their exclusivity protections.
Research and development (R&D) spending is slated to increase from its current level near 4% of total revenue to roughly 9% of total revenue by 2026. This continuous investment into R&D is expected to yield around $500 million in new product revenue each year from 2023 and beyond.
Finally, Viatris is worth a contrarian purchase because the latest damage to its share price has made its valuation practically irresistible. Its price-to-sales (P/S) ratio is near 0.7, which is far less than the pharmaceutical industry's average P/S ratio of 4.4. Therefore, each share of the stock entitles the bearer to a larger slice of revenue than what it would be, on average, within the industry.
While it's true that the company is expecting minimal growth this year, it isn't expecting to stop growing forever. As a result, daring investors who buy it at such a steep discount right now are likely to be rewarded when the market's sentiment warms once again.
For people who can't stomach the risk-taking that contrarianism implies, it's probably best to avoid Viatris for now. Though it may eventually become the stable, slow-growing dividend payer that conservative investors dream of, its recent crash means that it'll need to work hard to earn that reputation.
