We wrote about Takeda Pharmaceutical (TAK) in October and really liked what we saw when it came to company fundamentals. As we can see below on the technical chart, the descending triangle that was playing out at the time seems to have finally bottomed out. Suffice it to say, we expect higher prices from now on for reasons we’ll get to. What really appealed to us back then was the company’s vast pipeline with really encouraging opportunities in a multitude of sectors. In addition, and what was crucial for us, was that the company generated sufficient cash flow to ensure that the pipeline had every chance to prove itself. Management reiterated this on the recent earnings call by stating that its intention is to continue investing behind its growth engines, which will undoubtedly lead to increased R&D investment over the coming quarters. From a longevity perspective, that’s what investors want to see.
Shortly after this play in October, we actually took a long position in the stock (due to a sharp pullback in November) and sold a covered call against our position. When the position was close to maximum profit, we removed the position. Unfortunately, from our perspective, TAK stocks have rallied strongly over the past week, which means we can’t wait to get back here when the opportunity arises. We might consider selling put options in the February cycle as we have no problem being put in the stock here if that were to actually happen. When using a business for income purposes, it is all about protecting as much risk as possible. So from that perspective and aside from the technical aspects, here’s why we currently see limited downsides to Takeda.
First, it’s fair to say that many investors invest in Takeda for the generous yield of 5.4% and above. Therefore, to protect the downside, it is a question of maintaining the status quo to maintain the commitment of these investors. Well, any doubts that might have arisen among investors regarding increased spending in areas like R&D and the plasma therapy sector should have been dispelled by the recent announcement of share buybacks. The company plans to buy back nearly $900 million (up to 100 billion yen) of its own shares by the end of April this year. My reading here is that these purchases will be sporadic over the next few months as the dividend of JPY 180 per year will continue to prevail. Suffice it to say that more money needs to be returned to shareholders, so that should send a strong message to investors that management believes Takeda will have the wherewithal to continue to generously reward its shareholders. Moreover, growth will not be sacrificed due to sustained investments behind its growth drivers. Leverage also continues to decline on the balance sheet (debt-to-equity ratio stood at 0.75 at the end of Q2).
This is all possible thanks to the company’s focus on revenue as well as margins. The revenue growth performance in the first half of this fiscal year (6.8%) kept the full year guidance on track. Being fully aware of high spending in areas like R&D, core operating margins are expected to remain high. These trends above are bullish for sustained cash flow generation going forward. Additionally, due to the company’s recent debt restructuring and aggressive balance sheet deleveraging, Takeda is in a strong position with respect to its debt maturity profile. Although risks still remain when it comes to debt (the company issued bonds last October to refinance what is left on the JBIC loan), the company is close to being on the other side. regarding its debt reduction objectives. Again, these trends ensure that significant amounts of cash flow can continue to flow to shareholders as well as back into the business, again protecting against downside risk.
Suffice it to say, when we consider the above trends and peg them to Takeda’s current valuation, the downside risk becomes even slimmer. We say this because Takeda’s earnings, sales, assets and cash flow are all much cheaper than what we have become accustomed to over the past five years. Valuation matters and when a business grows its sales and assets that are generating strong profitability in terms of earnings and cash flow like we have now, it puts the odds in its favor in favor of a sustained rise in the share price before long.
Therefore, in summary, we continue to believe that there is strong upside potential for Takeda for the reasons outlined above. Due to the recent loss of our long position, we will be looking to implement long deltas here shortly and use Takeda primarily for income purposes. We look forward to continued coverage.