What To Do After Elanco Returned 66%

At the height of the March market sell-off, Elanco Animal Health (ELAN) took its time to form an uptrend. By May 15, when I last wrote about it, ELAN stock failed to trade back at highs reached at the start of the year.

Now that shares broke out and closed near their 52-week highs, should investors continue holding them? The stock now trades at 5 times sales and at a 30.2 times forward price-to-earnings ratio.

Elanco Gains 65.95%

SA Premium subscribers will get to view how ELAN stock performed since its very bullish rating.

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Source: SA Premium

Readers (and those who subscribe to DIY Value Investing) would have enjoyed gains that beat the S&P 500 index by almost three times.

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More recently, Elanco shares topped $34.09, only to pull back in recent days. Ahead of its November 6 quarterly earnings report before the market opens, shareholders are selling to lock in gains for the year. The company may beat expectations but after the rally from the lows, it is at risk of profit-taking selling pressure next.

Strong Second-Quarter Results

Elanco posted non-GAAP earnings per share of 9 cents. It lost 13 cents on a GAAP basis. Both figures beat expectations. Although gross margin topped 49.5%, revenue fell 25% to $586.3 million. The company benefited from a 2% price growth across its portfolio. It firmed its market share for its key companion animal products.

CEO Jeff Simmons explained the inventory reduction dragged revenue on a year-on-year comparison. With that effort complete, it is in a better position to realign inventory levels with its distributor partners. The write-down cost around $100 million, $45 million of which came from U.S. Companion Animal. Covid-19 also hurt its Global Food Animal business, costing it around $75 million to $85 million. So, investors should anticipate a potentially negative impact again as the Covid-19 pandemic picks up pace around the world.

Opportunity

Productivity gains and positive price added positively to its gross margin percentage of revenue of 49.5%. Operating expense declined 19% to $162.8 million, primarily lifted by a shift to virtual operations.

For the third quarter, Elanco forecast the following revenue range:

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Source: Elanco Q2 Earnings Call Presentation

The forecast excludes the $12-20 million in revenue from divested products for two months of the quarter. The outlook also includes Covid-19-related costs in the range of $30 million to $50 million. Still, the rising risks of the pandemic may lead to higher costs in Q3 and Q4.

Valuation

According to SA Premium data, Elanco fares poorly on value but well on growth and profitability:

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Despite the “D” score on value, Elanco stock is cheaper than that of Zoetis (ZTS). Per finviz, “Zoetis Inc. discovers, develops, manufactures, and commercializes animal health medicines, vaccines, and diagnostic products in the United States and internationally. It commercializes products primarily across species, including livestock, such as cattle, swine, poultry, fish, and sheep.”

On the charts, investors should notice that Zoetis stock has strong support on the 50-day and 150-day moving average:

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Chart Courtesy of Stock Rover

Conversely, the uptrend in the moving average convergence divergence affirms Elanco’s break-out, as shown below. But unless Elanco posts a strong earnings report next month, the stock could fall to the moving average at around $25-27:

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Once again, the multiples below suggest that the stock trades at elevated valuations:

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For example, the EV/EBITDA at 30.51 times is well above the sector median at 19.52 times.

On its conference call, CEO Jeff Simmons said,

Elanco grew 35% and outgrew the market. We grew 28% in Q2. So we’re outgrowing the market. So we’re growing share. I think that’s driven a lot by our capabilities. And it bodes extremely well as you know for Bayer that is leading in this and had the longest legacy in this segment.

Fortunately, Elanco’s debt/equity is 0.3 times. It does not expect to have any EBITDA issues and will operate easily above its debt covenant level. Furthermore, Elanco ended the quarter with $185 million, thanks to its strong operating cash flow. And just as Teva (TEVA), Bausch (BHC), and AbbVie (ABBV) acquired and took on debt, they are all creating real cash-flow growth. This will let them pay down debt every quarter.

Your Takeaway

Every time Elanco shares sold off in the last few months, its stock found support at the moving average. The stock may have around a 10% downside in the short term. The uptrend is still intact, so a dip in shares will give investors another entry point.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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