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Why Mallinckrodt Is Trading at a Discount on PE Basis

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Mallinckrodt’s valuation

On March 21, 2016, Mallinckrodt (MNK) was trading at a forward PE (price-to-earnings) multiple of 6.40x. This appears to be a discount compared with Johnson & Johnson (JNJ) and Teva Pharmaceutical Industries (TEVA), which were trading at forward PE multiples of ~15.3x and ~8.5x, respectively, as of the same day.

Valeant Pharmaceuticals (VRX), which is currently going through turmoil following a possible default and a lowered outlook for 2016, was trading at ~2.6x forward earnings as of March 21.

Why Mallinckrodt Is Trading at a Discount on PE Basis

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Specialty pharma industry performance

The median and average trailing PE for the specialty pharmaceuticals industry stood at ~23.9x and ~42.4x, respectively, and so Mallinckrodt’s trailing PE of 13.8x is lower than the industry average. Investors might be more concerned about the growth prospects and business model of the company after the Valeant turmoil.

Drug pricing pressure continues to hit the industry as a whole. The PEG (PE-to-growth) ratio for Mallinckrodt was 0.7, whereas the average PEG for the industry stood at ~2.7. Given Mallinckrodt’s future growth prospects, this ratio seems to be attractive at the current forward PE multiple.

Investor considerations for Mallinckrodt

The average sales growth for the specialty pharmaceutical industry is 18%, whereas Mallinckrodt witnessed a whopping sales growth of 60.7% in fiscal 2015. During the first quarter of 2016, its sales growth reached 20%, driven by volume rather than price increases. Its diversified product portfolio after its most recent acquisition should further reduce the company’s dependence on any single drug, such as Acthar.

With less penetration of Acthar, the company appears to have a significant opportunity to boost sales through volume growth. That said, Mallinckrodt seems to be at attractive PE multiple of 7x forward earnings. To get exposure to Mallinckrodt while controlling excessive company-specific risks, you might consider the SPDR S&P 500 ETF (SPY). Mallinckrodt accounts for 0.04% of SPY’s total holdings.

Continue to the next part for a closer look at Mallinckrodt’s business strategy.

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