Elanco Animal Health Stock: Bullish Beyond Near-Term Headwinds
Elanco Animal Health (NYSE: MOMENTUM) manufactures and distributes an extensive line of veterinary products for pets and farmed livestock covering everything from prescription and over-the-counter parasiticides to vaccines and therapeutics. The company’s 2020 acquisition of “Bayer Animal Health” from Bayer AG (OTCPK:BAYZF) enabled it to consolidate its position among the world leaders in the segment.
After a record 2021 highlighted by strong earnings and the post-pandemic recovery, one of the challenges at the start of this year is an outbreak of avian influenza which has added near-term uncertainties related to the exposure of Elanco at the poultry market. That said, we are bullish on ELAN, considering the recent selloff to be overdone given the company’s exposure to poultry is relatively limited while broader fundamentals remain strong. We see the stock’s value at the current level in several tailwinds for long-term growth.
Summary of ELAN finances
Ahead of Elanco’s upcoming first quarter results set for May 9, it’s worth reviewing current financials. The company last reported fourth-quarter results in February with annual revenue of $4.8 billion, up 46% year-over-year. The Bayer Animal Health deal contributed approximately $1.3 billion to revenue, meaning organic or pro forma growth was closer to 7%.
The company’s expansion into the companion animal segment, which now accounts for 50% of total sales, was accretive to margins last year. Indeed, gross margin climbed 460 basis points to 56.6% while adjusted EBITDA at 22.2% was significantly higher than 16.1% in 2020. Annual EPS at $1.05 more than doubled from $0.58 the previous year.
Management noted growth in all regions and for four of the top five animal species. Poultry revenue at $716 million, accounting for about 15% of the total, was a highlight with 14% year-on-year growth. On the other hand, pork-related products with sales of $464 million fell 9%, under pressure from a weak Chinese market following an outbreak of swine flu last year. We bring up this question because it helps put into context the current headlines about the wave of avian flu or “bird flu” sweeping through commercial flocks.
The latest reports indicate that a highly pathogenic avian flu “HPAI” detected in 30 states has so far resulted in the culling of more than 27 million chickens, turkeys and other birds or whose slaughter is planned for contain the spread.
As far as Elanco is concerned, the situation is believed to put pressure on demand for regular poultry flock medicines and maintenance consumables by farmers in the coming quarters. However, given the size of the segment, we expect the impact on overall business to be modest. The upcoming first quarter results will allow management to take stock of the market.
In terms of direction, the company was previously targeting 2022 revenue close to $4.8 billion, or 2% to 3% growth from 2021 in constant currency. This single-digit revenue growth range is close to the company’s “long-term growth algorithm” aiming for 3% to 4% growth acknowledging that this year faces tougher comparables compared to a record of 2021. More favorable is the trend of margin expansion which is expected to generate adjusted EBTIDA growth of 10% and an EPS target of between $1.18 and $1.24, representing a 15% year-over-year increase at midpoint.
ELAN stock price prediction
ELAN shares are down about 32% from its 2021 high, when it traded as low as $37.50. While some of the recent weakness is likely related to avian flu headlines, a few other factors could explain the stock selloff amid broader market volatility.
In some ways, the pet segment is exposed to consumer spending trends as a discretionary category that comes up against high inflation as a global theme putting pressure on global growth. There are fears that higher inflationary costs will squeeze ELAN’s margins and open the door to lower profits. We can also raise Elanco’s high debt level to nearly $5.7 billion following the Bayer deal. Although the company is profitable and generates positive cash flow, the high ratio of net debt to EBITDA above 5.5x has also weighed on the stock this year.
Nevertheless, it is important to recognize the long-term opportunity for the business. On the companion animal health side, Elanco benefits from a structural driver of growing demand with consumers caring for their canine and feline companions who are increasingly considered part of the family. More and more people around the world own pets. Global pet care spending is estimated to grow at a compound annual rate of 8.8% worldwide through 2027.
With farm animals, it is understood that improving welfare is essential for food supply and sustainable agriculture. On this point, the current market environment is particularly favorable to agriculture and food products. Beyond U.S. poultry farmers, protein producers around the world are benefiting from high market prices amid supply chain disruptions. We believe Elanco Animal Health’s livestock products are well positioned to benefit from increased sales this year under the stock’s bullish scenario.
Going back to the stock chart above, the $25.00 price level appears to be an important level of technical support since before the pandemic in 2019. There is evidence that Elanco’s long-term outlook is as strong as ever given the recent financial crisis. trends and its greater magnitude. By this metric, we believe the next move is higher as the stock regains momentum.
Is ELAN overvalued?
The market consensus is for Elanco 2022 revenue of $4.8 billion and EPS of $1.21, which is in line with management’s current guidance. Going forward, steady revenue growth of around 4% is expected in 2023 and overall 2024 earnings will accelerate by nearly 20% as the company fully realizes the synergies of the agreement with Bayer and increasing margins.
So overall, while Elanco doesn’t stand out as an outstanding growth stock this year, we like the stock’s value at the current level. We highlight that ELAN is trading at a forward P/E of 21x representing a discount to competitors Zoetis Inc. (ZTS) at 35x and Idexx Laboratories, Inc. (IDXX) at 52x. Similarly, ELAN is trading at a forward EV/EBITDA ratio of 16x which is also below the average for this group. Although each company has a different business model focused on different segments, ELAN’s valuation differential is attractive and we consider the stock to be undervalued relative to the sector.
Is ELAN a buy, sell or hold?
We rate ELAN as a buy with a price target for the coming year at $32.50, which represents an EV multiple of 18.5x on management’s 2022 EBITDA forecast or a multiple of 27x on the Current 2022 consensus EPS. We believe this level helps Elanco’s valuation premium move closer to its peers. Ultimately, we see earnings estimates rising on the belief that sentiment towards the stock is too weak, and the recent selloff more than accounted for short-term headwinds.
Heading into the first quarter report in early May, the main risk is the possibility that management revises its forecast downwards amid the avian flu outbreak. On the other hand, we believe that a more positive environment for agriculture and animal husbandry in general under tight food supply conditions can help balance the short-term impacts on poultry.