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Why Shire is now too cheap

Poor sentiment for global pharma companies and concerns for a specific division of the group have sent Shire’s share price below its risk-adjusted net present value
November 30, 2017

There is rarely a worse time for a company to lose a big chunk of expected sales than when it has just loaded up with debt. Unfortunately for rare-disease specialist Shire (SHP), that is the position it finds itself in, as competitors muscle in on key markets while it attempts to pay down the mountain of debt raised to fund last year's $32bn (£24bn) acquisition of Braxalta. And all this is happening against a backdrop of negative sentiment towards pharma companies prompted by US drugs-pricing controversy and quicker approvals of unbranded competitor drugs by the Food and Drug Administration (FDA).

IC TIP: Buy at 3712p
Tip style
Value
Risk rating
High
Timescale
Long Term
Bull points

Trading at a big historical discount
Pipeline drugs unaccounted for by current valuation
Improvement in operating cash flows
Strategic review could release cash

Bear points

High net debt
Negative sentiment in the wider market

As events have unfolded, Shire's shares have come in for a pummelling. The shares are 27 per cent down from their 52-week high in March, which represents almost double the 14 per cent decline from the FTSE All-Share Pharmaceuticals and Biotech index over the same period. And Shire is down 35 per cent from the all-time high it set in March 2015 compared with a 15 per cent decline by the sector. However, we think there are now strong grounds to view Shire's shares as too cheap; an argument that we feel is supported by the relatively muted share price reaction (a 3 per cent dip) to the latest blow to the company's prospects.

The most recent bad news for Shire concerns its hemophilia division (21 per cent of annual product sales). This has historically been a key market for Shire, but rising competition held back sales growth to just 4 per cent in the third quarter. But to make matters worse, this month peer Roche reported that its novel hemophilia drug performed better in a final-stage clinical trial than Shire’s newest product, which means analysts now expect a big blow to future sales. And Hemophilia is not the only part of Shire's business under strain. Generic versions of its drug Lialda caused third-quarter sales to plunge 58 per cent to $87m while manufacturing problems led to a 66 per cent fall in third-quarter sales of Cinryze to $57m.

But even with this plethora of problems, it is hard to see that much downside for the shares. Broker Liberum estimates that even if the entire value of Shire's hemophilia franchise were written off, a fair "risked" net present value (NPV) for the shares would be 3,419p – only 8 per cent below the current price. However, despite Roche’s success, there is still likely to be significant value in the hemophilia business as many existing users are likely to remain loyal. On Liberum's "base case" scenario, which forecasts a 25 per cent decline in non-inhibitor hemophilia sales between 2017 and 2022, the broker puts the risked NPV at 4,228p - 14 per cent above the current share price.

Moreover, there are some reasons to be bullish about Shire. Its immunology division (14 per cent of annual product sales) reported 32 per cent revenue growth in the third quarter of 2017 – 18 per cent ahead of consensus forecasts – thanks to strong demand for infection prevention medicine Gammagard. Its oncology franchise is also gathering momentum, and recently launched unique products Mydayis (for attention deficit hyperactivity disorder) and Xiidra (for dry eye syndrome) are also performing well.  

Meanwhile, self-help offers promise. Cost savings from the integration of Baxalta led to a 3 per cent reduction in general and administration expenses to $27m in the third quarter. And a manufacturing review has identified $100m savings from 2019 with the potential to increase this to $300m by 2023.  Manufacture of Cinryze should be bought in-house early next year to address the supply problems. And a strategic review of its neuroscience business could mean a spin-off to help alleviate debt issues.

Bringing debt down could prove a major catalyst for the share price. Having peaked at $23.6bn after the Braxalta deal last year, net debt at the end of the third quarter was down to $20.4bn. Liberum expects year-end net debt to be less than three times cash profit at the year-end, at $19bn, a reasonably comfortable 2.2 times cash profits by the end of 2018 and net debt of a very manageable 1.5 times by 2019.

This reduction in net debt could drive a serious re-rating of the shares given that, according to Bloomberg data, Shire's current forward earnings multiple of nine is in the bottom one per cent of the 10-year range. 

SHIRE (SHP)    
ORD PRICE:3,711pMARKET VALUE:£33.7bn
TOUCH:3,711-3,712p12-MONTH HIGH:5,067p3,435p
FORWARD DIVIDEND YIELD:nilFORWARD PE RATIO:9
NET ASSET VALUE:3,594ȼ**NET DEBT: 62%
Year to 31 DecTurnover ($bn)Pre-tax profit ($bn)Earnings per share (ȼ)Dividend per share (p)
20156.42.74390nil
201611.44.04437nil
2017*15.15.44500nil
2018*15.65.76570nil
% change+4+6+14-
Normal market size:500   
Matched bargain trading    
Beta:1.1   
*Broker Shore Cap forecasts, adjusted PTP and EPS
**Includes intangible assets of $53.1bn, or 5,841ȼ a share    £1=$1.34