Goldman Sachs On Specialty Pharma: Buy Catalent, Sell Valeant

Investors are hard pressed to find a standout in the specialty pharmaceutical space as many companies lack the "positive narrative" that can be found the rest of the biopharmaceutical space, analysts at Goldman Sachs said in an industry-wide report.

The Analyst

Goldman Sachs' Dana Flanders and Christopher Staral initiated coverage of Catalent Inc CTLT's stock with a Buy rating and $50 price target. The firm also initiated coverage of Valeant Pharmaceuticals Intl Inc VRX's stock with a Sell rating and $18 price target.

The Thesis

Heading into 2018 the sentiment within the specialty pharma space showed signs of improvements, the analysts said in a note. However, it's too early for investors to get constructive as the industry has yet to fully benefit from "complex" generic launches and a string of recent disappointments, such as the launch of generic Copaxone.

There are some opportunities for investors in the space, including companies with specialty brands that boast durable and volume-driven growth opportunities. A return to M&A activity in the space represents an "under-appreciated" catalyst for several companies over the next two to three years.

Catalent: Near And Longer-Term Catalysts

Catalent, a leading global manufacturer of consumer and animal health products, saw its organic growth accelerate throughout fiscal 2017 amid solid execution and strength in the end-market, the analysts said. The momentum is likely to continue through fiscal 2021 and the company should show a 7.5 percent compounded annual growth rate through this time period. The company's growth will also come from the Cook acquisition which adds a strategic and double-digit growth asset.

Catalent's management is reviewing its annual organic growth targets (revenue growth of 4 to 6 percent and EBITDA growth of 6 to 8 percent), but could revise its outlook higher within a few quarters, the analysts said. This should also add confidence to the company's ability to expand its margins after multiple years of downward pressure.

Catalent's near-term focus of operational execution would likely be followed by a strategic M&A evaluations over the longer-term. This would represent a longer-term upside driver given the fragmented nature of the space, coupled with the company's history of successful acquisitions.

Valeant: Valuation Concerns

Valeant has taken multiple necessary steps to improve its business outlook, including asset sales and extending maturities, the analysts said. As such, management has a "clear pathway" to run the business until 2020 and should achieve a mid to low single digit topline growth profile and generate $1.5 billion of annual operating cash flows.

Multiple risks to Valeant's business remain, however, including a levered balance sheet above 7 times and litigation risks, the analysts said. A sum-of-the-parts valuation model using comparable companies for B&L/International, Branded Rx, Neuro and generics results in the stock being worth $18 per share. This figure doesn't include additional legal settlements which represent a downside case to the company's valuation.