Organon: what is the recipe? (NYSE: OGN)
A year ago, I concluded that there was fertile ground for the actions of Organon & Cie (NYSE: OGN) in this premium article. The fallout from Merck & Co., Inc. (M.K.R.) saw some volatile trading after his split, and with stocks lagging, it looked pretty interesting.
Since the shares began trading on their own early last summer, the shares have shown some volatility in a trading range of $28 to $38 in the first few months after trading, and trading towards the lower bottom of that range at the time, I found the valuation attractive.
Organon’s spin-off from Merck has been well-prepared as the spin-off process began in early 2020, allowing the company to operate separately under Merck’s ownership prior to the formal spin-off. Organon generated $6.6 billion in sales in 2020 through women’s health, including unintended pregnancy, treatment of women with peri- and post-menopausal symptoms, uterine fibroids, and more.
The company is organized into two segments with “established brands” being the largest segment with 49 products representing together $4.5 billion in sales. The women’s health sector generated $1.6 billion in sales from 10 products, including some biosimilars.
The company is a truly international, or better said, global cash cow. Some 80% of sales are generated overseas, with the company posting adjusted EBITDA of $2.8 billion, which translates into very strong margins. While there are exclusivity issues and concerns, the counter-argument is that the product range is quite broad, with real diversification seen as no single product is responsible for more than 10% of sales. Still, it’s not all been great, as the company forecast 2021 sales to grow from $6.6 billion in 2020 to $6.1-6.4 billion in 2021.
Based on $2.8 billion of EBITDA, I’ve pegged after-tax cash flow at about $1.6 billion after deducting $200-300 million of capital investments, $400 million dollars in interest charges and a tax rate of 25%. Such a number would equate to earnings of $6.50 per share based on about a quarter of a billion shares outstanding.
With shares trading at $33, this reduced earnings to just 5x, although lower sales and leverage were the counter arguments. Leverage was a very big argument, with net debt posted at $8.6 billion at the time, actually exceeding its equity valuation of $8.3 billion at the time, although that leverage is manageable at 3.1x EBITDA, even though that EBITDA was likely around $2.5 billion in 2021, increasing leverage ratios to 3.5x.
Weighing it all up, I thought the value argument prevailed because I initiated a position, and after stocks hit a high of around $40 earlier this year, stocks are now back at $28 per share and change.
In November last year, the company announced an agreement to acquire Forendo Pharma in a deal worth just $75 million upfront, although regulatory and commercial achievements could drive the value of the agreement to almost a billion. In February, sales for the full year were reported at $6.3 billion and while sales were down just 3%, adjusted EBITDA margins fell 10 percentage points to 38%, standing just under $2.4 billion. That translates to adjusted earnings of $6.54 per share and GAAP earnings of $5.31 per share, with many reconciling items looking fairly fair, with net debt fairly stable at $8.4 billion.
The company reported flat sales of $6.1 billion to $6.4 billion in 2022, pretty flat year-over-year, but adjusted EBITDA margins are around 35%, as it shows a further pressure on margins and EBITDA just below $2.2 billion. This translates to a headwind on pretax earnings of around $0.80 per share, but earnings should still be around $6 per share on an adjusted basis, while increasing the leverage ratio on an adjusted basis. relative.
The company cut its full-year sales forecast to $6.1-6.3 billion as it released second-quarter results, driven by the stronger dollar. The problem is that the midpoint of the EBITDA forecast is down to 33%, implying that EBITDA is rapidly falling towards the $2 billion mark. With stable net debt around $8.4 billion, leverage ratios went 3x to 4x due to lower adjusted EBITDA.
The truth is that I understand the cautious stakes of the company over the past year. While sales are holding up well, we’ve seen EBITDA grow from $2.8 billion to $20 billion in the meantime amid a strong dollar, but significantly softer prices.
With stable net debt over the past year, amid weak cash flow conversion, absolute debt is stable and relative leverage ratios are rising, making investors cautious about the dynamics of higher relative indebtedness and rapidly increasing pressure on margins.
Amid all of this there is little short term green shoot for the stock as the long term valuation argument remains and is actually very attractive as it was last year but true execution is needed at some point.