Endo (ENDP) reports Q3 earnings Thursday. Analysts expect revenue of $784.6 million and eps of $1.01. The revenue estimate implies a 10% decline Q/Q. Investors should focus on the following key items:
Lack Of Top Line Growth
It is one thing to talk about a double-digit decline in Endo’s top line. It’s another thing to actually watch it unfold. Some investors still hold out hope that the worst is over for Endo. We will find out Thursday. The war on rising drug prices has hurt Endo in general. The war on opioid sales have hurt the company specifically. In Q2 2017 Endo’s $876 million in revenue was off 5% Y/Y.
The devil is in the details, however. Generics (62% of total revenue) was flat. Revenue from U.S. Generics was down 34% Y/Y. However, it was offset by growth in Sterile Injectables (up 27%) and new product launches (up 70%). U.S. Generics is facing pricing pressure from large clients with out-sized negotiating power. The FDA has accelerated approvals of new generics launches, which has hurt pricing of existing drugs. The question is whether revenue from new product launches will be able offset that decline. I believe it’s possible this quarter, but long-term it could be an issue.
Endo’s Branded drugs (28% of revenue) include pain related treatments like Opana and Percocet. Branded drugs fell 15% and I expect it to free fall this quarter. President Trump has declared a war on opioid sales and that could start by tamping down the rising number of opioid prescriptions. That could put Endo particularly at risk. The company’s Opana was so addictive that the FDA asked the company to remove it from the market. The loss of Opana (4% of revenue) and headwinds in other pain-related products will likely be the main culprits to drive total revenue down. The company’s ability to replace this revenue stream could determine the future of the stock.
In Q2 Endo did a good job of managing costs. Though revenue was down, EBITDA rose 23%; EBITDA margin was 40%, up from 31% in the year earlier period. The biggest driver was the improvement in gross margin from 31% in Q2 2016 to 38% last quarter. Endo also cut SG&A from 21% to 18% last quarter. The company’s ability to wring costs out of the business is key to maintaining its credit metrics. Its $8.3 billion debt load is now at 5.2x and it could deteriorate if cost cuts do not keep pace with revenue declines.
While cash flows begin with EBITDA, they end with working capital management. At Q2 Endo’s $49 million in working capital was rather paltry. Through the first six months of 2017 it generated free cash flow of $281 million. It must improve upon that if the company wants to pare debt. Valeant’s (VRX) improved working capital management has helped it pare its $26 billion debt load. If Endo followed that example it could potentially energize its investor base as well.
Endo’s cost containment measures have been stellar. ENDP is down over 65% Y/Y Until its top line erosion subsides the stock remains a sell.