Organon: Thoughts Before Third Quarter Earnings (NYSE: OGN)

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In my last note for Seeking Alpha on Organon (New York Stock Exchange: OGN) ahead of the company’s second quarter 2020 earnings, I expressed some reservations about the company and its ability to replace falling revenue within its division of established brands with new product launches within its Women’s Health and Biosimilars Divisions.

The good news, at least, is that Organon’s dividend yield has increased since my last note, from ~3.5% to 4.3%, but the bad news is that the share price has fallen, by 28%. % in the last 12 months. and 18% in the last three months.

As a reminder, Organon was formed as a result of Merck spinning off its Women’s Health, Established Brands and Biosimilars division – good news for Merck, which realized a ~$9bn tax windfall – but a challenge complicated for Organon, given the revenue from the established brand. the brands are in terminal decline due to the age of the products, the Women’s Health division has had low revenues, little profit for several years, and the biosimilars division is very small.

However, after the spin-off, the market gave Organon a low enough valuation to suggest the stock was significantly undervalued, and that argument still stands. announcing Income Q222 of $1.59 billion, Organon’s management forecast full-year revenue of $6.1-$6.3 billion, which is only a few hundred million dollars less than the company’s current market cap valuation of $6.7 billion.

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Organon FY22 targeting as of Q222 (Organ presentation)

Looking at the full guidance and doing the math, Organon appears to be anticipating a net profit of ~$1.1 billion, resulting in a fiscal year earnings per share (“EPS”) of $4.3, about the same as in FY21, and a forward price-to-earnings ratio of ~6x.

As I mentioned in an article about Viatris (VTRS), the product of a merger between Pfizer’s Upjohn division of Legacy Brands and generic drugmaker Mylan, earlier today only 50 companies out of the 500 largest publicly traded companies had a selling price (“P/S”) of less than 1 in 2021, and only a few had a price/earnings ratio of less than 6x.

That might imply that Organon stock is cheap and will grow, but the problem is that the company’s top-tier revenue is shrinking, not growing, and that is apparent to all, as is the fact that sales of these marks are on the terminal. decline.

Does that mean Organon shareholders should think about dumping their shares? Many shareholders probably would not have bought Organon stock by choice, but since they owned Merck stock, they inherited one-tenth of Organon for every Merck share they owned.

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It’s a complicated situation, and frankly, in my opinion, it may be some time before Organon can cope with its shrinking revenues and a debt load inherited from Merck that amounted to $8.3 billion in the second quarter of 2020 and start to increase the stock price.

However, that possibility shouldn’t necessarily be ruled out: in this post, I’ll first briefly review Q222 earnings, discuss what to look for when Q322 earnings are released in 3 days, and speculate on a reasonable price to pay for Organon shares. and a reasonable price to sell at.

Q222 Earnings Review

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Organon earnings walk Q222 (earnings presentation)

As we can see above, Organon’s year-over-year earnings performance is quite favorable, as currency difficulties (an element of the business outside of management’s control) are the main reason revenues didn’t actually grow year-over-year. . If prices were down, then volume appears to have more than offset any losses.

Organon achieved ex-FX revenue growth across all geographies: Conducts vast majority of sales overseas, Europe & Canada: 28% of all Q2 2022 revenue, Asia Pacific & Japan: 18 %, China, 15% and Latin America America – 14%.

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Organon Q222 Franchise Performance (Organon Earnings Presentation)

However, looking at the franchise’s performance, it’s clear how heavily Organon is dependent on its established brand division. Although this division’s revenue appeared to grow between 1H21 and 1H22, these comparisons may not be reliable as Organon’s shares only began trading in May 2021, making year-over-year comparisons difficult. As I wrote in my last note:

Established brands consist primarily of cardiovascular drugs, which accounted for $1.6 billion, or 26% of product sales in 2021, Respiratory: $1 billion in sales, 16%, dermatology, bone health, and non-opioid pain management: $830 million, 13%, and other established brands such as Proscar Benign Prostatic Hyperplasia (“BPH”) Therapy – $117 million sales in 2021. These products are sold by a global network of ~4k sellers.

Sales of these pharmaceuticals are unlikely to grow; frankly, had Merck management thought they would, they wouldn’t have spun off, so expect Women’s Health and biosimilars to make up for any decline.

Here, the news is not so good. Women’s Health revenue fell 1% y/y in 1H22 after discounting exchange rate headwinds, and this is a traditionally tough market.

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Organon has made some strategic acquisitions to drive revenue growth, which I discussed in more detail in my last note, and target markets for new products, for example bacterial vaginosis, contraception, endometriosis, preterm labor and postpartum hemorrhage, add up to more than 100 million patients.

There is competition from companies like Myovant (MYOV) MYFEMBREE in endometriosis, although the maximum sales expectations for that product are over a billion dollars, so maybe Organon can move forward in this field as long as it can compete with a more new.

Finally, while an exciting industry with reasonably strong growth prospects, Organon’s biosimilars division is small, with only five approved products. Organon will have high hopes for Humira’s biosimilar Hadlima, given the $20bn-per-year sale Humira loses patent protection next year, but Hadlima will compete with other generics in a market that could shrink to ~$10k million per year based on lower prices. and newer products.

So it’s hard to see Hadlima (approved in August) generating more than a few hundred million in peak sales, but that said, a total revenue contribution of $500 million would certainly help offset losses from established brands. , and biosimilars shipped at $217 million. revenue in 1H22. A contribution of more than a billion dollars a year by, say, 2024 should prevent Organon shares from falling too far and maybe even reinvigorate them.

Looking into the Q322

Unfortunately, given the strength of the dollar, FX headwinds are likely to be a drag on Organon’s performance on the T322. To reach its FY22 target of ~$6.2 billion, Organon will need to match or nearly match Q2 2022 performance, and currency headwinds may well make that challenging.

On the positive side, some analysts believe that the performance of established brands should remain strong for quite some time, although they admit that long-term decline is inevitable.

If the performance of Established Brands is strong and Women’s Health and Biosimilars revenue grows in double digits operationally as they did in Q22, then there is reason for optimism, however, if management revises guidance lower again as it did in the T222, that could have negative implications for the share price

Debt management is another key metric for Organon. Initially saddled with ~$9.4bn of debt, the figure stood at ~$8.9bn as of Q2 2020, which is ~4x expected fiscal year EBITDA, an unarguably high amount of leverage. Organon is not especially cash rich, reporting $545 in cash on hand as of Q222.

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In the third quarter of 2011, Organon reported $1.6 billion in revenue ($5 million sequential increase) and gross profit of $991 million, with net income of $323 million. For the next 3 quarters, earnings were $1,603, $1,567, and $1,585 with net income of $202, $348, and $234. I would expect Q322 earnings to closely mirror Q222, with relatively tight profit margins, but I would certainly expect profitability, and that’s at least a good sign.

Conclusion: still profitable, still in transition, still in debt: I do not anticipate much increase in profits from Q322

As I suggested in my Viatris note, spin-offs are all the rage at Big Pharma, with Sanofi (SNY), GSK (GSK), and Johnson & Johnson (JNJ) following Merck and Pfizer’s lead. The reasoning is simple: developing new drugs is more lucrative and generates higher profit margins.

As such, these spin-offs face tough challenges: maximizing revenue from brands whose best days are behind them, coping with high net debt leverage, and trying to find value in struggling divisions where the parent company couldn’t.

The market recognizes these challenges and prices drift accordingly. Initially, low valuations seem like amazingly good investment opportunities, but then the underlying issues present themselves and investors understand that P/S and P/E ratios can widen significantly due to falling earnings, rather than rising value. share price.

However, every problem is also an opportunity, and Organon shareholders benefit from a high dividend yield, excellent pre-built infrastructure, experienced management, and some volume of more or less guaranteed income from older brands.

That explains why I personally don’t give up on Organon. As long as women’s health and biosimilars drive double-digit revenue growth and sales from established brands don’t decline too much (keep an eye out for the latest Q3 earnings numbers when they’re released Thursday), Organon has a breather and management has a chance to grow the business, on a budget that is admittedly tight.

Profitability is a rare thing in the pharmaceutical industry outside of big pharma, health insurers and life sciences, but Organon still has it, quite simply. If that is still the case a year from now, and the debt load has been reduced, and new product launches in Women’s Health and Biosimilars are making significant contributions, the share price rally should come. However, it is unlikely to happen overnight.

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