Finding Shelter in a Low P/E, High Yield Trade

It was a brutal end of the trading week for most investors as the market cratered on Thursday and Friday on increasing concerns around a faltering economy. It is amazing how fast the narrative has moved from a focus on the strong initial reading of Q2 GDP growth of 2.8% to worries that if the central bank doesn’t start cutting rates immediately, the economy will be in recession. On the bright side, investors with dry powder have lower entry points to deploy some of that ammo.

I still think the market has further to fall so today we are targeting a healthcare stock with a more-than-reasonable valuation and solid dividend yield. It's very much along the lines of the successful forays we have made in recent months into Gilead Sciences GILD, Pfizer PFE, and Perrigo Group PRGO. 

In fact, this name is a spinoff from drug giant Merck MRK called Organon & Co. OGN. Organon is a global healthcare concern with a portfolio of more than 70 medicines and products with a primary focus on women’s health, including birth control devices. In addition to its feminine offerings, the company markets five immunological or oncological biosimilars and a line of established branded therapies.

Since Organon was spun off from Merck in 2021, the company has attempted to leverage its expansive manufacturing (six sites) and sales footprints by purchasing the commercial rights to approved medicines in what it deems heretofore unexploited geographies from other pharmaceutical concerns, many of them — like the ones bequeathed from Merck — established brands that have lost or are close to losing patent exclusivity.

The company produces a bit over $6 billion in annual sales and management has projected that it will deliver roughly $2 billion in adjusted EBITDA in 2024. The stock trades at under five times forward earnings. 

The key reason for the minuscule valuation is Merck spun Organon with around $9.3 billion in long-term debt. Management has reduced that to $8.7 billion, with major maturities due in 2028 and 2031. The company’s current annual interest payments run around $525 million.

If Organon wasn’t so loaded with debt, its gambit of buying established brands or creating biosimilars and leveraging its commercial operations to market them would command much higher multiples. In addition to paying down debt, management uses its free cash flow to pay shareholders a generous dividend, with a current yield of 5.4%. 

If interest rates continue to fall, the company could benefit from being able to roll over debt at lower rates. Regardless, at this point the stock is cheap. Especially when one can enhance the yield and provide some downside protection with a simple covered call strategy.

Option Strategy

Here is how one can initiate a position in OGN utilizing a covered call strategy. As a reminder, covered call orders involve buying an equity and simultaneously selling just-out-of-the-money call strikes against the new position.

Selecting the January $20 call strikes, fashion a covered call order with a net debit in the $18.10 to $18.30 a share range (net stock price - option premium). Liquidity is solid with the options against this equity. 

This strategy provides downside protection of 15% over the trade’s duration, which includes two quarterly dividend payouts of $0.28 cents a share. The strategy all offers 12% return potential of more than 12%, including dividends, even if the stock moves down slightly over its five-and-a-half-month option duration.

At the time of publication, Jensen was long GILD, OGN, PFE and PRGO.