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Morningstar | Momentum Continues in the Second Half; Shares in Mayne Pharma Undervalued

We are not making any changes to our AUD 1.30 fair value estimate or no-moat rating for Mayne Pharma after the company reported full-year results slightly ahead our expectations, with adjusted EBITDA of AUD 165.3 million versus our forecast USD 158 million. Despite the ongoing momentum in the second half, and management’s positive comments regarding a more stabilised generic pricing environment, there was little in the briefing that would alter our medium-term view of the company. At current levels, and allowing for our very high uncertainty rating, we consider shares in Mayne Pharma as undervalued.

We think the launch of six new products in the second half should maintain momentum in the U.S. generics division and offset anticipated competition arising from the entry of two new generic entrants to lead product generic Dofetilide in fourth-quarter 2018. We also think prospects for the specialty brands division remain attractive. We expect the expanded sales team to maintain strong growth of the foam products, Fabior and Sorliux, and promote the recently acquired generic Efudix to U.S. dermatologists. Additionally, the growth of late-stage formulation development work, including clinical trial manufacturing, in the contracting services division should expand the addressable market for that business.

Mayne’s U.S. generics division, housing the beleaguered Teva acquired portfolio, is rebounding, suggesting that heightened price deflation experienced in calendar 2017 is returning to more normal levels. We think this suggests the company’s strategy of targeting niche markets is offsetting continued competition in the oral contraceptive products and are encouraged by management’s citing its number-one or number-two positioning in 60% of its portfolio. In the absence of specific product information, we assume the six new generic products launched in the half will provide about a 3% uplift to revenue in the generics division and mitigate the impact of generic competition on Dofetilide, which we assume will lead to a 10% decline in sales for fiscal 2019. Further, we see ongoing transfer of third-party manufactured products to Mayne’s U.S. manufacturing plant as positive for gross margins in the generic division and see these trending back toward 56% by 2023, from 46% in fiscal 2018.

Increasing sales in the specialty brands division force bode well for increasing reach and depth of engagement with U.S. dermatologists to drive sales of a complementary suite of branded products, spanning Doryx, Sorilux, and Fabior. We see the 121% sequential increase on first-half 2018 revenue for this division as evidence of traction in the foam products, and we expect this to continue, albeit at a slower rate, given the company’s decision to expand the team to 114 sales representatives. Including the recently acquired Efudix product, we expect this division to generate a four-year revenue CAGR of 11%.

Contract services continued to grow impressively, achieving another 20% increase in constant currency. We think providing an end-to-end service offering bodes well for expanding the commercial opportunity and see first commercial manufacturing revenue from a full-service client as an important step in building credibility in this regard. We remain bullish on the contract service, given the size of the U.S. pharmaceutical market, and remain comfortable with a four-year revenue CAGR of 8%.

Despite the solid financial results, Mayne Pharma’s balance sheet gearing deteriorated slightly in fiscal 2018, with net debt/underlying EBITDA of 1.7 times increasing from 1.3 times in fiscal 2017. Nonetheless, cash flow from operations for fiscal 2018 was a healthy AUD 137.3 million, up from a negative AUD 25.8 million in the prior corresponding period. As such, with construction of the Greenville plant now largely complete and the growing portfolio of in-house manufactured products adding to margin, we expect these debt levels to remain manageable.