Investor Essentials Daily

This drug developer is doing business like a portfolio manager

Jazz Pharmaceuticals (JAZZ)
March 6, 2024

The pharmaceutical industry is known for its high volatility and complexity, making it a challenging sector for average investors due to the specialized knowledge required to understand drug development and market dynamics.

Pharmaceutical stocks, especially those of smaller biotech firms, are susceptible to significant price fluctuations based on trial results.

However, Jazz Pharmaceuticals (JAZZ) challenges the notion of pharmaceutical investments being overly risky by focusing on developing and commercializing innovative medicines for unmet medical needs, a highly profitable niche with strong demand and substantial pricing power.

Despite these tailwinds, rating agencies have concerns over Jazz’s financial health following the significant acquisition of GW Pharmaceuticals.

Today, we’re exploring Jazz’s credit risk through the lens of Uniform Accounting to determine the accuracy of rating agencies’ assessments of the company.

We can use Uniform Accounting to put the company’s real profitability up against its obligations and decide for ourselves the true risk of this business.

Also below is a detailed Uniform Accounting tearsheet of the company.

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The pharmaceutical industry is notorious for leaving investors with hopeful investments with pennies on the dollar.

It’s a complex industry seemingly not meant for the average investor.

For instance…

Pharmaceutical stocks can be highly volatile, especially smaller biotech firms that are often dependent on the success of a single drug. News of trial results, either positive or negative, can result in significant stock price swings.

Likewise, the science behind drug development is complicated, requiring specialized knowledge to truly understand a company’s prospects. This makes it difficult for the average investor to make informed decisions.

So clearly, it seems like every pharmaceutical company would be a very risky investment.

But Jazz Pharmaceuticals (JAZZ) puts this statement to the test.

Jazz Pharmaceuticals is a global biopharmaceutical company focused on developing and commercializing innovative medicines to address unmet medical needs.

The unmet medical needs segment of pharmaceuticals is highly profitable. There is a desperate need for effective treatments in these areas, creating a high level of demand almost immediately upon release.

Likewise, due to the limited options available, pharmaceutical companies have substantial pricing power, allowing them to set high prices for genuinely innovative therapies.

For example, Jazz has been dominating the sleep medicine market. In fact, its medications are the sole treatment options for minimizing nighttime sleep issues in those with narcolepsy, a serious sleep disorder.

Taking this a step further, Jazz has made it nearly impossible for competitors to enter the narcolepsy drug market. This class of drug has a controversial history for its unfortunate side effect that it can be used to force people to fall asleep.

As a result, Jazz was forced to ensure the drug was only distributed to the intended customers… and it was able to patent that distribution process as well.

This narcolepsy drug has an even stronger moat than most drugs do, which is why it has had such strong and stable returns for years.

Adding to that, Jazz has taken its profits from its cash cow drug to start investing in its future pipeline. Since 2016, the company has spent nearly $10 billion buying new drugs and entire pharmaceutical companies, including its landmark GW acquisition.

Today, the company operates more like a portfolio management company than a true drug developer.

Rating agencies have been sour on the Jazz since its considerably large acquisition of GW Pharmaceuticals in 2021.

S&P gave the company a “BB-” rating, indicating a significant risk of default at nearly 11% over the next five years. It also puts the company in the high-yield basket.

Given its solid financial standing, we believe Jazz deserves a more secure rating.

We can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (“CCFP”) to understand how the company’s obligations match against its cash and cash flows.

In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).

The CCFP chart shows that Jazz’s cash flows alone are more than enough to serve all its obligations going forward.

The chart indicates that the company is on solid financial ground and is very likely to fulfill its obligations with ease in the next five years.

The company has limited debt maturities in the next 5 years and it can easily handle its obligations with its massive cash flows.

GW Pharmaceuticals acquisition led to increased debt for the company but this also helped transform its business model from being a drug developer to more like a portfolio management company in the pharma industry.

This transformation helps Jazz have more stable revenue streams and profitability. Additionally, its debt is manageable due to its significant cash flows.

Our review of Jazz shows that the company has a low risk of default, contrary to what rating agencies indicate.

Therefore, we are assigning an “IG3” rating to the company, which places it in the investment-grade basket, with a risk of default of about 1%.

It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.

To see Credit Cash Flow Prime ratings for thousands of companies, click here to learn more about the various subscription options now available for the full Valens Database.

SUMMARY and Jazz Pharmaceuticals (JAZZ:USA) Tearsheet

As the Uniform Accounting tearsheet for Jazz Pharmaceuticals (JAZZ:USA) highlights, the Uniform P/E trades at 8.7x, which is below the global corporate average of 22.9x but above its historical P/E of 7.0x.

Low P/Es require low EPS growth to sustain them. In the case of Jazz Pharmaceuticals, the company has recently shown a 65% Uniform EPS shrinkage.

Wall Street analysts provide stock and valuation recommendations, that in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Jazz Pharmaceuticals’ Wall Street analyst-driven forecast is a 22% and 12% EPS growth in 2024 and 2025, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Jazz Pharmaceuticals’ $132 stock price. These are often referred to as market-embedded expectations.

Furthermore, the company’s earning power in 2023 was 3x the long-run corporate average. Moreover, cash flows and cash on hand are 3x its total obligations—including debt maturities and capex maintenance. The company also has an intrinsic credit risk that is 30bps above the risk-free rate.

Overall, this signals a low credit risk.

Lastly, Jazz Pharmaceuticals’ Uniform earnings growth is in line with its peer averages and is trading within its average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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