Philippine Markets Newsletter

Scientific breakthroughs helped this South Korean pharma company reach peak Uniform ROA of 18%

July 28, 2021

In this day and age, innovation and technological advancement have yielded numerous scientific breakthroughs.

In the pharmaceuticals industry, these breakthroughs meant higher revenues for this company. Despite this, as-reported metrics show the company struggling to break through return on assets (ROAs) above 10%. TRUE UAFRS-based (Uniform) return on assets shows quite the contrary.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Wednesday Uniform Earnings Tearsheets – Asia-listed Focus
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While the pharmaceutical industry has a direct impact on the growth and progression of the global economy, the development of the health sector is often undermined by insufficient funds or the lack of pioneers.

However, if there is one important lesson that the pandemic has imparted, it is the global heightened focus on health.

The search for an effective COVID-19 treatment has surpassed the demand for any product or commodity. Countries across the globe have been tirelessly funding vaccination plans and research initiatives to put a halt to the virus.

Due to the exponential increase of cases and aggressive variants, the formulation of effective treatment for COVID-19 has been a top priority. A company that is greatly benefiting from this is Celltrion Inc., a homegrown South Korean enterprise, which is now South Korea’s leading pharmaceutical corporation.

One of Celltrion’s R&D success stories is its 2013 launch of the world’s first biosimilar monoclonal antibody Remsima. These biosimilars play an integral role in the treatment of cancer, viruses, and autoimmune diseases.

The increased demand for biosimilar drugs is largely attributed to their cost efficiency. The global market for biosimilars in 2022 is forecasted to reach $20.8 billion.

Due to the high demand for these innovative treatments, Celltrion’s revenue has continued to rise over the years. In 2020 alone, the company’s revenue reached $1.6 billion, a 64% improvement from the previous year.

This medical success has pushed the company to develop other innovative drugs. It is now preparing for the launch of Herzuma and Truxima, which are oncological biosimilars. Additionally, the company is also focusing on Temixys, a drug for HIV treatment.

To address the recent global health crisis, Celltrion formulated an antibody treatment designed to slow severe symptoms of COVID-19.

The antibody treatment for COVID-19, Rekirona, has shown promising results in all three trial phases. It has gained traction and approval from various countries with regard to emergency applications.

Celltrion’s success primarily stems from its innovative formulations, enabling the company to distinguish itself from other well-known competitors.

However, even with its successful drugs, as-reported metrics still show lackluster returns.

For the past fourteen years, as-reported ROAs have always been below 11% levels.

On the other hand, Uniform Accounting gives us a clearer view of Celltrion’s real profitability. For the past fourteen years, Uniform ROA has been stronger than what as-reported metrics show, ranging from 5% to 18%.

One metric that causes distortions in as-reported ROAs is its amortization expense.

Amortization expense is generated from the company’s use of intangible assets in a given reporting period. As such, it is a non-cash expense that is spread throughout the intangible asset’s useful life. As a non-cash expense, it does not represent an actual cash outflow.

Deducting amortization expense from the company’s revenues distorts its profitability because there is no actual cash flow that happens when amortization is charged.

Adding back amortization expense is necessary to convert the company’s net income into actual cash flows.

After amortization expenses and other significant adjustments are made, we can see that Celltrion has better profitability than what as-reported metrics show. Currently, the company’s Uniform ROA is at 18%, which is almost twice the as-reported 10%.

Celltrion’s profitability is much more robust than you think

As-reported metrics are distorting the market’s perception of the firm’s profitability. If you were to just look at as-reported ROA, you would think that the company is a weaker business than real economic metrics reveal.

Celltrion’s Uniform ROA has been higher than its as-reported ROA for the past fourteen years. For example, when Uniform ROA was at 18% in 2020, as-reported ROA was only 10%.

The company’s Uniform ROA for the past fourteen years has ranged from 5% to 18%, while as-reported ROA has ranged only from immaterial levels to 10% in the same timeframe.

Specifically, Uniform ROA dropped from 13% in 2007 to 5% in 2008, before remaining at 13% to 15% levels from 2009 to 2012. It then fell to 8% in 2013, before gradually rebounding to 18% in 2020.

Celltrion’s Uniform earnings margins are weaker than you think but its robust Uniform asset turns make up for it

Volatility in Uniform ROA has been driven by trends in both Uniform earnings margin and Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

After dropping from 55% in 2007 to 21% in 2008, Uniform margins reached 58% to 60% peak levels from 2010 to 2013 before falling to 41% in 2014. Then, Uniform margins reached 52% in 2017, before stabilizing at 39% to 41% levels from 2018-2020.

Meanwhile, Uniform turns gradually increased from 0.2x in 2007 to 0.4x in 2009 before declining to 0.1x in 2013. It then gradually rebounded to 0.4x in 2020.

SUMMARY and Celltrion Inc. Tearsheet

As the Uniform Accounting tearsheet for Celltrion Inc. (068270:KOR) highlights, the Uniform P/E trades at 36.1x, which is above the global corporate average of 23.7x but below its own historical average of 45.2x.

High P/Es require high EPS growth to sustain them. In the case of Celltrion, the company has recently shown a 62% Uniform EPS growth.

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

We take sell-side forecasts for Korean International Financial Reporting Standards (K-IFRS) earnings and convert them to Uniform earnings forecasts. When we do this, Celltrion’s sell-side analyst-driven forecast is a 34% and a 13% EPS growth in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Celltrion’s KRW 268,500 stock price. These are often referred to as market-embedded expectations.

Celltrion is currently being valued as if Uniform earnings were to grow 20% annually over the next three years. What sell-side analysts expect for Celltrion’s earnings growth is above what the current stock market valuation requires in 2021 but below that requirement in 2022.

Furthermore, the company’s earning power is 3x above the long-run corporate average. Also, cash flows and cash on hand are over 10x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals a low credit and dividend risk.

To conclude, Celltrion’s Uniform earnings growth is below its peer averages. However, the company is trading above its average peer valuations.

About the Philippine Market Daily
“Wednesday Uniform Earnings Tearsheets – Asia-listed Focus”

Some of the world’s greatest investors learned from the Father of Value Investing or have learned to follow his investment philosophy very closely. That pioneer of value investing is Professor Benjamin Graham. His followers:

Warren Buffett and Charles Munger of Berkshire Hathaway; Shelby C. Davis of Davis Funds; Marty Whitman of Third Avenue Value Fund; Jean-Marie Eveillard of First Eagle; Mitch Julis of Canyon Capital; just to name a few.

Each of these great investors studied security analysis and valuation, applying this methodology to manage their multi-billion dollar portfolios. They did this without relying on as-reported numbers.

Uniform Adjusted Financial Reporting Standards (UAFRS or Uniform Accounting) is an answer to the many inconsistencies present in GAAP and IFRS, as well as in PFRS.

Under UAFRS, each company’s financial statements are rebuilt under a consistent set of rules, resulting in an apples-to-apples comparison. Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Every Wednesday, we focus on one company listed in Asia that’s relevant to the Philippines and that’s particularly interesting from a UAFRS vs as-reported standpoint. We highlight one adjustment that illustrates why the as-reported numbers are unreliable.

This way, we gain a better understanding of the factors driving a particular stock’s returns, and whether or not the firm’s true profitability is reflected in its current valuations.

Hope you’ve found this week’s Uniform Earning Tearsheet on an Asian company interesting and insightful.

Stay tuned for next week’s Asia company highlight!


Angelica Lim
Research Director
Philippine Markets Daily
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