Organon (OGN) 21Q2 Update

21Q2 Performance in Line with Expectations; Raising Performance Rating and Lowering Price Target

21Q2 GAAP EPS of $1.68 was lower than 20Q2’s $2.14.  Although sales increased 4.5% to $1.6 billion, costs were higher as a result of new tolling arrangements with Merck and certain costs associated with the spin-off and becoming a separate public company.  Still, the results were in line with my expectations.  Organon has initiated a quarterly dividend of $0.28.

Management reaffirmed its full year 2021 guidance on key metrics.  My projections, which are consistent with management’s guidance but above consensus, anticipate GAAP EPS of $5.88 and non-GAAP EPS of $6.45.  They do not include possible unusual or one-time items such as restructuring costs, acquisitions and additional costs associated with the spin-off.

Management remains confident in Organon’s ability to achieve organic revenue growth in the low- to mid-single digits.  By year-end, the risks associated with loss of exclusivity in Established Brands, which accounts for two-thirds of sales, should be minimal.  The remaining one-third of sales, from Women’s Health and Biosimilars, is poised to grow at double-digit rates.  In addition, my projections indicate that Organon will generate significant free cash flow which can be used to expand through acquisitions, licensing, joint ventures and internal development.  With that profile, OGN should be able to grow earnings in 2022 or 2023 and beyond.

Accordingly, the stock’s current valuation of less than six times forward earnings seems unjustifiably low.  It most likely reflects a “show-me” attitude by the market on management’s assertions that it can grow the business.  Nevertheless, I am raising my performance rating on OGN by one notch to “strong outperform.”  (My previous performance rating was set in April, before the stock began trading on a when-issued basis.) I am also reducing my price target to $45, based upon a reconsideration of Organon’s valuation vs. its peer group. My new price target represents a multiple of 8 times projected 2022 GAAP earnings of $5.64 or 7.25 times projected 2022 non-GAAP earnings of $6.21, based upon yesterday’s closing price of $33.16.

This is a summary of my recent update report on Organon. For the full report, contact me directly.

A follow-up note about valuation: My initial price target, set well before the spin-off, assumed that Organon would be valued in line with its large pharmaceutical peers, at 12-13 times forward non-GAAP EPS. That analysis failed to take into consideration the unique nature of Organon’s business (i.e. that two-thirds of its revenues would be generated from drugs that had lost exclusivity and thus were subject to significant generic competition). I also failed to note the existence of another comparable company – Viatris, the November 2020 spin-off from Pfizer – which also holds a portfolio of therapeutics that have lost exclusivity and is pursuing a similar strategy to capitalize on its global manufacturing and distribution platform. Viatris (VTRS), which is currently posting net losses on a GAAP basis, is valued at only four times forward non-GAAP EPS.

Although Organon’s profile differs in some important ways from Viatris – i.e. its focus on Women’s Health and Biosimilars, which have double-digit near-term sales growth potential, its assertion that it expects to achieve low- to mid-single-digit organic revenue growth and its ability to generate free cash flow in excess of $1 billion for at least the next few years which can be used to grow the business – the comparison with Viatris cannot be ignored. Indeed, it appears to be a key factor in Organon’s current valuation of less than six times forward non-GAAP earnings.

Yet, while comparable valuations are useful as reference points, they are not the absolute determinant of valuation for individual stocks. Internal earnings dynamics are much more consequential. After all, comparable peer group valuations are an average of the individual valuations of their constituents. In Organon’s case, its ability to grow revenues and earnings over the long-run matters more than where it seems to fit today in the pharmaceutical industry constellation (given its short operating history).

The bottom line here is that Organon’s ability to grow its earnings over the long-run will matter more than whether it looks more like Viatris or other pharmaceutical industry peers today. If the company can achieve consistent low-to-mid-single-digit sales growth (and presumably mid-single digit or better earnings growth), its forward valuation multiple will move higher, and an eventual valuation multiple consistent with or even better than its the pharmaceutical industry average cannot be ruled out. (In fact, one could argue that a stabilized portfolio of drugs that have lost exclusivity may eventually be worthy of a higher valuation multiple than drug portfolios with significant LOE risk.)

I have lowered my price target (or fair value estimate) for Organon’s stock from $71 to $45 based upon what appears to be current investor sentiment. Over a six to twelve month time frame, which is the basis of my performance ratings and price targets, a target of $45 seems more realistic and achievable given the stock’s current valuation and recent trading dynamics. However, I have by no means ruled out the possibility that the stock can achieve my original price target over the intermediate term.

August 25, 2021 (with the note on valuation posted August 26, 2021)

Stephen P. Percoco
Lark Research
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