Cephalon Still Undervalued After Outstanding Quarter

Biopharmaceutical firm Cephalon (CEPH) reported first quarter results on Tuesday afternoon that proved the company is off to a solid start in 2010. Profit rose 89% to $110.6 million or $1.35 per share compared to a year ago where the company earned net income of $58.6 million or 75 cents per share. However, ex-items the biotech firm reported $1.76 per share and topped Wall Street analysts’ expectations by $.20.

Revenue for the quarter grew by almost 15% to $596.6 million versus expectations of $586.3 million. Sales of Treanda, the company’s non-Hodgkin’s lymphoma treatment, grew by 62% in the quarter and were easily one highlight of the results. Although, not all drugs surpassed expectations as Nuvigil, their new sleep disorder drug intended to cushion sales once blockbuster sleep drug Provigil faces generic competition, failed to achieve growth targets.

Looking ahead to the rest of the year, the company offered mixed guidance. They raised the EPS guided range by 20 cents to $7 to $7.20 of profit per share in 2010. However, Cephalon management was content to leave revenue guidance unchanged and below analysts’ estimates at $2.61B to $2.69B. Still, the guided range would imply growth of 19% to 23% from a year ago. Guidance for the current quarter followed the same pattern with EPS guided above expectations but sales forecasts were more conservative than consensus expectations. The company continues to focus on cost controls as they lowered SG&A guidance by more than 5% to $910M to $930M, which explains how they intend to achieve better margins.

In addition to the regular reporting on operations, Cephalon also unveiled their best estimates as far as how healthcare reform will affect their business. They expect legislative changes (discounts on drugs and taxation of drug subsidies for retirees) to cost the company around $7-$11 million in 2010. Additionally, different healthcare related expenses may cost the company $11-$19 million in 2011. With that said, Cephalon believes that starting in 2014 the nearly universal insurance coverage will begin to provide a tailwind as opposed to the headwind the early expenses will cause.

At Ockham, we are reaffirming our Undervalued stance on Cephalon as of this week as the company is off to a very strong start. Of course, we have reservations about the company’s failure to prove Nuvigil as a quick and easy replacement for Provigil, but we think the strength from other drug franchises offsets these concerns. The stock has fallen nearly 14% since the FDA declared an unfavorable ruling on Nuvigil for the treatment of jetlag, but the company continues to promote the drug aggressively for its approved uses.

At the time of writing the stock is trading relatively flat, even after the earnings beat and higher guidance. If they are able to hit the low end of their earnings target for this year, the company seems quite cheap at less than 9x 2010 earnings. Investors must decide for themselves how much of the upcoming loss of Provigil has been priced in at this point. While Nuvigil may not replace all of the Provigil revenue lost to generics, we are confident in the rest of the company’s products that are growing well and diversifying their revenue mix. For further evidence of diversification, they recently announced the completion of their acquisition of Mepha AG which gives them a place in the generic market.

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