EUR 850.00 For Business Accounts Only

Morningstar | Higher Expenses the Backdrop to Disappointing Mayne Pharma Result, FVE Reduced to AUD 1.05

No-moat-rated Mayne reported a first-half result below our expectations, despite improvement on the previous corresponding period, or pcp, across key metrics. This included a 13% increase in revenue on the pcp to AUD 274.4 million, a 16% increase in underlying EBITDA to AUD 81.2 million, and a 35% increase in underlying net profit after tax to AUD 21.1 million, with all slightly under our full-year expectations.

Except for the highly competitive generic products division, or GPD, all segments experienced positive revenue growth on the pcp. Representing 64% of group revenue through the first half, GPD revenue was down 3% on the pcp as generics continued to come under pricing pressure. In this instance, this was largely due to several competing drugs being approved to Dofetilide, which saw its sales drop 73% to USD 9 million. We expect competition to remain fierce in the GPD segment, putting pressure on margins.

We adjust our margin assumptions downward by about a percentage point over the next five years after lowering our expectations of the earnings leverage Mayne can benefit from through their sales and distribution expenditures. We’ve also increased our assumed weighted average cost of capital to 9.8% from 8.8%, to reflect the very high uncertainty we see in the business. Our reduced AUD 1.05 fair value estimate suggests Mayne remains undervalued, but to a lower degree than previously estimated.

Offsetting the weakness in the GPD segment, the higher-margin speciality brands division, or SBD, increased revenue by 213% on the pcp, as all products grew sales, including FABIOR (up 97% on the pcp) and SORILUX (up 73%). Metrics contract services, or MCS, revenue were up 14% on the pcp, to USD 33.9 million, as the new Greenville facility improves manufacturing capacity. Finally, Mayne Pharma International, or MPI, which makes up 8% of sales, experienced a 13% increase in sales to AUD 21.3 million, driven by sales in specialty products MONUROL and UROREC.

Mayne’s pipeline remains strong, with the highlight of the first half being the approval of antifungal product TOLSURA. Specifically, a development pipeline of over 25 multi-source products targeting the U.S. markets with sales greater than USD 5.0 billion and 14 products pending approval with the FDA with a total market value greater than USD 3.0 billion provides a solid product platform for the future growth. All these products reflect Mayne’s continued therapeutic focus on dermatology, women’s health and ID/pulmonology, with dermatology now Mayne’s largest therapeutic category. The TOLSURA market is estimated at USD 200 million alone but with a potential broadening use of the product, could reach four times this according to management.

However, higher than expected R&D and SG&A expenses were a key theme of this result. An AUD 7 million increase in R&D to AUD 12 million was mainly due to an increasing focus on specialty brands programs and early-stage clinical development, which do not meet the criteria of capitalisation. Otherwise, an AUD 7 million rise in marketing and distribution costs to AUD 35 million was due to the expanded U.S. dermatology sales team, while SG&A expenses also increased sharply on the pcp, up AUD 12 million to AUD 95 million.

We have changed our forecasts following the results and management guidance. We have adjusted upwards our SG&A cost assumptions through our forecast period after the spike in the first half of fiscal 2019 and the guidance provided by management, averaging about a percentage point of revenue higher annually. Given the material operating leverage in the business, this significantly impacted on our valuation. We have also revised down our fiscal year 2019, and subsequently future year, revenue assumptions for the GPD segment, following a disappointing first half. Our fiscal year 2019 revenue assumption for the GPD segment is now AUD 341 million, about 30% lower than previously.

Mayne’s financial structure profile remains stable, with key metrics showing slight improvement in the half. Although net debt was up 4% in the half to AUD 299 million, net debt to EBITDA fell to 1.5 times from 2.1 times--well under the covenant requirement of 3.25 times. Other key covenants include a minimum interest cover (EBITDA/interest) ratio of 3 times and a minimum shareholder funds balance of AUD 800 million. Both are comfortably satisfied as at Dec. 31, 2018, with interest cover at 11.9 times, up from 11.2 times at June 30, 2018; and shareholder funds up AUD 100 million in the period to AUD 1.3 billion. Near-term liquidity remains reasonable, with cash on hand of 96 million and USD 190 of undrawn debt supported by improved operating cash flows, which were up 11% in the period to AUD 53 million. A well-spaced out debt maturity schedule further minimises short-term refinancing and liquidity risk.

Following on from the financial structure, one key feature of the result we didn’t particularly like related to working capital management. Specifically, the extension of terms by one of Mayne’s customers, worth AUD 44 million, resulted in increased working capital of AUD 35 million. Not an insignificant amount, management rationalised this via their interpretation this brings all three major U.S. customers into line on the same terms, assuring investors on the earnings call this would not set a precedent with other key distributors. Rather, this represents a step-up in working capital going forward.