Don’t Sleep Through Cephalon’s Growth

Cephalon (CEPH) is a biopharmaceutical company that we have highlighted in the past, and they reported another outstanding quarter after the close on Tuesday.  The company’s most successful drug is Provigil, which is used to treat some sleep disorders, but for some reason we think the market has been lulled into sleepiness when it comes to this growth story.

The company reported revenue of $712.4 million, or 32% growth over the second quarter last year.  Adjusted for income per share came in at $2.20 per share, 41% better than a year ago and $.43 cents better than Wall Street expected (that is after 9 analysts upped their targets in just the last month).  The company experienced growth in all different categories of drugs with oncology drug Treanda being a standout from the bunch.

Not only was last quarter a successful one for Cephalon, but they also raised full year earnings guidance for the second straight quarter.  Now the company expects earnings per share of between $7.45 and $7.65 on sales of $2.63 billion to $2.71 billion.  Analysts’ estimates are calling for $2.73 billion which may provide some reasoning behind the market’s lackluster response to the earnings report.  In fact, at the time of writing the stock is trading off nearly 3% in after hours.  Management’s outlook for the third quarter is also viewed as conservative on the revenue side, but exceeds profit estimates.

The last time we wrote about Cephalon (Cephalon Still Undervalued After Outstanding Quarter) they had just reported a great first quarter, yet still the stock is trading at about the same price level.  We have to urge value investor to view this stock as an opportunity, and not miss the forest for the trees.  The company has a history of offering uninspiring revenue guidance and then consistently outpaces it.  Meanwhile, their profitability continues to surge higher, and after five years averaging nearly 26% EPS growth, the company now trades for less than 9x this year’s earnings.

Even the sales forecasts that have spooked the market are priced attractively in our view.  For example, over the last ten years the market has been willing to pay between 2.23x and 3.56x revenue per share for Cephalon, but at management’s current estimations—which are likely conservative—the stock is trading at a price-to-sales multiple of just 1.75x.  For all of these reasons, we have placed an Undervalued rating on Cephalon and will not downgrade it based on the improving fundamentals seen in this earnings report.  We think Cephalon is a growth stock that a value investor can appreciate, and investors with a long term focus ought to take a serious look.  With its established drugs as well as its promising pipeline, we think it may be a takeover target with many of the mega-drug companies facing serious patent cliffs in the next couple of years.

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