Organon ($OGN) — FY21 Update

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Price: $39 Market Cap: $10bn Valuation: 8x FCF / 8x EBITDA Category: General

FY21 Review

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Biosimilars & Women’s Health grew nicely in Q4 and full year but still make up only 1/3 of total revenue (at 4Q21).

2021 felt the brunt of patent losses in the Established Brands segment so there shouldn’t be many surprises over the next few years. Just like Viatris, it is a business susceptible to competition and pricing so there will be a “base business erosion” of ~3% in 2022. Volume will offset some of that erosion but it’s a possibility that the established brands are more-or-less running in place over the next few years.

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Guidance

Organon is ramping up R&D spend in 2022 leading to slightly lower EBITDA margins. On mid-point guidance, 2022 revenue would be $6.25bn and EBITDA at $2.19bn (vs. $6.3bn and $2.4bn in 2021).

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Capital Allocation

Management has 3 priorities:

  1. Maintain dividend at ~20% of FCF
  2. Organic growth via capex between 3-4% of sales
  3. Toss-up — acquisitions and discretionary debt reduction

Thoughts & Valuation

The timing of the OGN spin-off from Merck was done with the patent expiration headwinds in mind. Management is (rightfully) very confident on the predictability of revenue and cash flows which leads to their comfort with slightly higher leverage than peers (3.5x leverage target).

Organon recently hit ~$39 per share which puts it at a $10bn market cap on 255m shares outstanding. They paid down a good amount of debt in 2021 so net debt is ~$8.3bn at yearend for an $18.3bn enterprise value.

Estimates are at $2.2bn in 2022 EBITDA and $5.47 EPS — 8.3x EBITDA and 7.2x PE.

Competitors trade at a pretty wide range of multiples depending on their individual circumstances but 8-10x EBITDA and 8-13x PE seem to be the norm.

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  • At 10x EBITDA / 10x PE — OGN would be valued at $55 per share (+40% from today’s $39 share price). That might be a lofty price target given the debt and big portion of the business facing flat-to-declining sales.
  • At 9x EBITDA / 8.4x PE — OGN would be worth $46 per share (+18%) — which seems more realistic.

I like the high-visibility into cash flow over the next few years but without a substantial change in multiple, it’s getting pretty close to a fair value, so I’ve started taking some off the table. It’s still close to a 3% position as of March 2022. My counterpoint to myself — OGN will reach their leverage target in FY22 after which there will be a LOT of FCF available for repurchases or M&A; it’s likely that the street is underestimating earnings potential per share in FY24-25 and beyond after capital allocation.