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Morningstar | Modest Signs of U.S. Generic Pricing Deflation Easing: Mayne Pharma Shares Remain Undervalued

We think the recent positive messaging from majors Novartis and Teva bodes well for the U.S. generic pricing dynamics, and we maintain our fair value estimate for no-moat Mayne Pharma at AUD 1.25 per share. Specifically, in Novartis' second-quarter 2018 earnings call this week, with respect to its generics business, management cited continued price declines, albeit at a slightly lower rate than previous years. In our view, this represents a slight improvement in fundamentals and supports commentary provided by Mayne Pharma at the interim regarding increasing stabilisation and rationality relating to its generics business.

This follows earlier comments in May by industry behemoth Teva Pharmaceuticals, when it announced, without disclosing specific products, that it will exit certain competitive products with lower profit margins. We think this is indicative of a broader trend in the industry, consistent with our thesis, around contestable markets becoming less attractive, eventually leading to an exit of industry players, and in turn to more sustainable pricing environments for the remaining participants. We see this trend as positive for Mayne Pharma, given that 77% of its U.S. product pipeline is targeting opportunities with three or fewer generic players, and we see decreased competition as stabilising pricing deflation in these markets.

Our forecasts remain unchanged, with expectations for Mayne’s key generic division generating around AUD 370 million, or 66% of group revenue in fiscal 2018, and a five-year revenue CAGR of negative 4% for the division. This incorporates our view on stabilisation of fundamentals over the medium term and compares with the 12% year-on-year decline expected for fiscal 2018. At current levels, shares in Mayne Pharma screen as undervalued, albeit with a very high fair value uncertainty rating.

Mayne Pharma remains in good financial health with cash on hand of AUD 63 million versus debt of AUD 340 million. As such, gearing remains relatively low, with net debt/EBITDA of around 1.30, together with an undrawn debt facility of USD 155 million.

Further, we expect that the transitioning from contract manufacturing to in-house manufacturing at the company’s U.S. facility will support margin expansion over the next five years. As such, we expect growth of free cash flow to outpace top-line revenue growth over the period.