Sometimes it can pay off to buy into spin-offs. A spin-off is formed when a corporation takes part of its business and separates it from the parent company. Perhaps the business being spun off is considered to be non-core to the parent, or management believe that the company will do better by standing on its own two feet.
Today, I’m going to look at a company spun off from the £40bn mega-cap Reckitt Benckiser (LSE: RB) at the tail end of last year — and why I’d be more inclined to buy Indivior (LSE: INDV) than its parent.
Going it Alone…
Indivior was listed as a new company at the end of last year: it is the former pharmaceutical division of Reckitt Benckiser. The shares began life on the stock exchange trading at 150p per share. Using my 20-20 hindsight, this was a cheap price: the shares currently change hands at around 240p — that’s not a bad gain in just over six months. As you can see from the chart, the stock has trounced the FTSE 100 and the parent company.
So, what has caused its outperformance? It is possible that the market likes the current price to earnings ratio. On a trailing 12-month (TTM) basis, the shares trade on a P/E of just over 7. This means that it is currently one of the cheapest stocks in the market. As we know, however, the market looks forward. The company’s major product, Suboxone Film (used to treat people with an opioid dependence), came off-patent in 2010. As one would expect, this has caused earnings fall from $614 million in 2011 to $363 million in 2014, while earnings are expected to fall further as the company faces increased generic-drug competition going forward.
It could also be the current product pipeline of new products to treat opioid addiction and other illnesses over the next five years that has raised investors’ attention.
Opioids are prescribed to treat acute pain; however, there is a plethora of opioid overdoses, and Indivior has several products in its pipeline that could treat opioid addiction and overdoses:
- Monthly Buprenorphine Injection — this injection would be used to treat opioid addiction. Phase III trials were due to commence in 2015, if all goes well, the product could be launched in 2017.
- Nasal naloxone – this is a medication used to counter the effects of opioid overdose, delivered via the nose. It could be exported beyond the US next year, with obvious benefits.
The company has several other products at various other stages of testing prior to regulatory filings. Should these be given the all-clear, I would expect the market to re rate these shares accordingly.
Never Underestimate The Moat…
Having said what a good company Indivior could be, I think that investors would be wrong to write off its parent, Reckitt Benckiser. Whilst some more value-orientated investors may think that this company looks expensive in price-to-earnings terms, currently nearly 23 times forward earnings. You need only look to the sage Warren Buffett, who hunts for businesses that can protect their returns with an enduring ‘moat’.
For Buffett, the company needs to be able to stave off the threat of competition by erecting formidable barriers — indeed, why wouldn’t others want to try for a piece of the pie if they can see a profitable space to do business?
The word ‘moat’ is, for some, the first thing that they look for in a business. They want to buy shares of a company that can generate market-beating profits from dominant market positions, respected brands and pricing power.
As a consumer defensive, Reckitt Benckiser operates in an extremely competitive space, yet still manages to deliver:
- Return on capital (ROCE) – 21.2%
- Return on equity – 25.3%
- Operating margin – 24.5%
These quality scores make it a very difficult beast to beat.
So, Why Would I Buy Indivior?
Personally, I like smaller operators like Indivior. They can be less well researched by the market, thus creating opportunities for investors to look a little further down the leaderboard.
To me, it looks like the market is starting to warm to Indivior, with brokers becoming more positive on the stock, and importantly upgrading their earnings estimates. This is currently not the case for its parent, Reckitt Benckiser, with brokers downgrading heir earnings expectations for 2015 and 2016. As such, I currently see Indivior as the better buy.