Endo Is Not Out Of The Woods Yet

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There is a war being fought over rising drug prices and Endo Pharmaceuticals (ENDP) is right in the middle of it. It has gotten lumped in with hedge fund hotels like Valeant (VRX) and Turing Pharmaceuticals who acquire brands, raise prices and slash R&D. Endo might have hit an inflection point as it underlying business begins to slow. ENDP is off over 60% Y/Y; I expect it to fall further. I explain below.

Endo’s Line Growth Could Continue To Slow

In Q2 2017 Endo’s $876 million in revenue was off 5% Y/Y. Revenue generics and international was flat, while branded drugs fell by double digits.

Within the generics segment revenue from U.S. generics fell 34%; generics are suffering from negotiated price cuts with big clients and an acceleration in generic drug approval by the FDA, which has increased competition. This was offset by strong sales of Sterile Injectables and recent launches of ezetimibe tablets (generic Zetia) and quetiapine ER tablets (generic Seroquel). The combination of new product launches and growth in Sterile Injectables helped stabilize generics this quarter, but will it be enough going forward?

The branded pharmaceuticals segment is a mixed bag. It consists of specialty products (45% of branded sales) and pain-related drugs (55% of branded sales) like Percocet and Opana. The company’s pain-related drugs experienced a revenue decline of 30% Y/Y, offset by growth in specialty products. In June 2017 the FDA [i] alerted Endo that risks of Opana outweighed its benefits and [ii] asked the company to remove the opioid from the market due to its public health consequences of abuse.

Opana’s $32 million in revenue is about 4% the company’s total revenue. The loss of revenue and EBITDA could hurt operations in the second half of 2017. A continued diminution in other pain-related drugs could also hurt.

Endo Is Highly-Indebted

Management has done a yeoman’s job in steering the company through its decline. It has been cutting cost to soften the blow. The company rationalized product certain products within its U.S. generics segment. This decreased cost of goods sold and allowed gross margin to improve to 38% in Q2 2017 versus 31% in the year earlier period. Cuts to R&D and SG&A expense allowed EBITDA margin to improve to 40% from 31% last year. On a dollar basis EBITDA actually 24% Y/Y, despite the fall in revenue.

Nonetheless, Endo’s $8.3 billion debt load is at 5.2x run-rate EBITDA. The company might not be able to continue to cut its way to earnings growth, particularly given the loss of its Opana income stream which will likely kick in this quarter. Endo’s liquidity is also lacking. It has cash of nearly $1 billion, but working capital of only $49 million. This might not be enough of a cushion in case the business turns down.

Conclusion

Endo is rightsizing its cost structure but its exposure to generics and pain-related drugs is a headwind. Its debt load will be difficult to pare from current cash flow. Avoid the stock.

 

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