Friday, August 07, 2009

King Pharmaceuticals (NYSE:KG): Upgraded to Buy at Merrill Lynch/BAM

Merrill Lynch/BAM is upgrading King Pharmaceuticals (NYSE:KG) to Buy from Neutral with a $14 target (prev. $10).

Firm notes that while KG faces near-term headwinds, they believe these issues are already largely reflected in the stock’s low relative valuation. They believe that the approval and commercial success of Embeda, which could be the first “abuse-deterrent” opioid available in the US, could drive the shares higher over the next 12 months.

Big market opportunity for less abusable product
KG’s clinical work has shown that crushed Embeda capsules have a similar abuse potential relative to intact capsules, and significantly lower abuse potential relative to immediate-release morphine. This is important given that opioid abusers commonly crush drug to facilitate faster absorption (through oral, injectable, and nasal routes). At branded pricing, the firm estimates the long-acting morphine and opioid markets represent sales opportunities of $1.5bn and $7.1bn, respectively.

Raising target to $14 from $10 on DCF methodology
Because EPS could vary significantly in the near/mid term due to various factors (ie launch spend, Skelaxin generic timing), Merrill Lynch believes a discounted cash flow (DCF) analysis may be more appropriate than a P/E approach to assessing the long-term value of KG. For reference, their $14 target equates to a 2010E P/E multiple of 13.6x, relative to the group average (12.4x) on 2009E.

KG expects approval soon
ALO filed for approval of Embeda on 6/30/08 and the application was granted priority review status with an FDA action date of 12/30/08. The FDA extended the review without setting a new action date. According to KG, the extension was primarily related to the risk evaluation and mitigation strategy (REMS) proposal. At an investor meeting with KG management that the firm hosted on 7/7/09, KG described an “almost daily” back-and-forth with FDA, and that it continued to believe that final approval was weeks (not months) away. On its 2Q09 earnings call on 8/6/09, KG expressed confidence that it is close to approval.

Notablecalls: I like this call as:

- It's a tier-1 firm upgrading KG. Merrill (still) has a large following.

- The chart looks good

- There's a n-t catalyst in place (Embeda approval).

I think KG will trade to $10 (or possibly higher) on this upgrade.

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