Viatris (NASDAQ: VTRS) began publicly trading via a spin-off merger. Since then, the stock has underperformed due to selling pressure. As the herd flees, opportunities arise for value investors. Moreover, the stock is extremely undervalued compared to its peers. Investors who investing with a margin of safety should consider Viatris as it offers an attractive dividend yield of 4.8%. More so, the company is considering a buy-back program after the sale of the biosimilar assets. Free cash flow remains strong to support shareholder returns and reinvestments.
Split – Merger
In November 2020, Viatris was formed by the merger of Mylan and Upjohn (a division of Pfizer (PFE)). Although Pfizer shareholders received Viatris shares, many of them sold their shares as soon as they got them. For example, large-cap fund institutional investors sold shares of Viatris because they were forced to sell their shares since Viatris is a mid-cap stock. Consequently, selling pressure began to hammer the stock once Viatris began trading on the Nasdaq. The stock is now down 40% from November 2020 as investors are still unsure what to do.
Value investors like to do the opposite of the herd. Therefore, Viatris could be a great example because there is a lot to like. Chris Davis, a well-known value investor, increased his Viatris position to a 3-3.5% weighting in the Davis New York Venture Fund. The fund has slightly outperformed the S&P 500 over the past 40 years with an annual return of 12.16%.
High Free Cash Flow Enables High Dividend Yield
In the first quarter of 2022, Viatris reported $1.07 billion in free cash flow. This is primarily due to the strength of operating activities and the timing of capital expenditures. For the full year 2022, the company expects free cash flow to be between $2.5 billion and $2.9 billion. On the other hand, the dividend payment is estimated at approximately $580.4 million for the year (excluding a possible increase in the dividend).
This translates to a payout ratio of 23% of free cash flow for the downside, giving the company plenty of headroom to pay down debt and reinvest in the business. Therefore, the dividend yield of 4.8% is relatively safe and already provides investors with an excellent return on their investment.
Attractive valuation compared to peers
In the charts below, I’ve compared Viatris competitors and peers in terms of EV to EBITDA and free cash flow yield. EV to EBITDA gives us a general overview of the health of a stock. The companies that stand out the most are Viatris and Novartis (NVS), as both trade well below the industry average.
Since EV to EBITDA does not include capital expenditures, it is important to bring free cash flow to the table. Capital expenditures can weigh on a company’s total free cash flow and reduce potential funds for R&D or acquisitions. Viatris has by far the most attractive free cash flow yield and it doesn’t even come close. As a result, the company has much more leeway to reinvest in the business, pay down debt, pay dividends, and buy back stock.
Restructuring opens huge buyout potential
In early 2022, Viatris announced the sale of its biosimilar portfolio to Biocon Biologics. The sale grants Viatris $2 billion in upfront cash, $1 billion in convertible preferred stock representing at least a 12.9% stake in Biocon Biologics, and up to $335 million in additional payments. Although the assets were sold at 16.5x EBITDA, investors took the news extremely negative as it could potentially destroy the company’s growth.
But let’s not forget that this company recently merged. Therefore, the most important factor must be the synergy between the two companies, which can only be created when there is convergence. Additionally, it frees up R&D, capital for reinvestments and share buybacks.
There are four criteria that Viatris is currently focused on, as CEO Rajiv Malik mentioned at Goldman Sachs’ 43rd Annual Global Healthcare Conference:
Can we unlock a trap value? Can the capital be released? Can we simplify the Society? And do we have assets that are perhaps better in the hands of another target player than one of the assets in our hand?
To compensate for the lower growth in the sale of biosimilars, the company is also considering a gradual and diligent increase in R&D investments.
Additionally, takeovers are very likely, as CFO Sanjeev Narula mentioned during the conference:
The proceeds that we will get $4 billion net of tax and net of this repayment of these divested assets will provide us with enough firepower for the stock buyback, additional BD – grow BD and organically invest in the company .
A $1 billion share buyback plan would create 8.5% of shareholder value. Combine that with the dividend yield of almost 5% and the risk-reward balance looks very favorable in these uncertain times.
The two risks that are important to monitor are the high level of indebtedness and a possible reduction in free cash flow.
Leverage can amplify investment returns and increase buying power, but too much leverage can create risky environments. Currently, Viatris is highly leveraged relative to its free cash flow, but the company is proactively reducing debt. For 2022, Viatris is on track to repay $2 billion in debt.
A decline in free cash flow could send Viatris shares further down. Even so, one-time merger costs are decreasing, SG&A expenses are decreasing, and synergies between the two companies could perhaps increase free cash flow. The expected increase in R&D spending should also be good for the business as mentioned by the CEO during the conference:
If you follow us for four, five or six years, that’s what we spent, $600 million, $700 million on R&D and we got $600 million, $700 million in annual launches. So that’s a pretty good 1:1 ROI if you spend there.
I rate Viatris as a strong buy below $10 per share. The risk/return balance is favorable to long-term investors. Dividend yield and undervaluation are too attractive to ignore. In view of the high free cash flow yield and EV to EBTIDA ratio, few peers even come close to Viatris. In addition, the management team is aware of the risks and proactively keeps them at bay. Finally, a buyback program can boost the stock price in a positive momentum environment.