Big Pharma stocks are in the trenches. The U.S. government is closing in on the pharmaceutical sector in a pincer-like movement.
On the one hand, there are more and more signs that the government wants to cap medicine prices (at least while a democrat holds the Oval Office). That, of course, puts the bread and butter of Big Pharma stocks directly in the crosshairs.
On the other hand, Big Pharma’s hope for lower tax rates — a key for maintaining profitability in a challenging environment — was intercepted by the U.S. government.
With the squeeze coming from both sides, it’s important to stay focused on quality. Some pharma companies are well positioned to come out stronger on the other side.
Those are the cherries that are worth keeping. Meanwhile, the other pharmaceutical stocks should be ditched before they drag you down with them.
Big Pharma Stocks to Buy: Teva Pharmaceutical Industries Ltd (ADR) (TEVA)
Why You Should Buy: Strong long-term thesis
Sometimes, one has to look beyond just the numbers and toward the bigger picture, i.e. the true potential of the company, the way it’s managed. TEVA (TEVA) is such a case. Despite some fluctuations in its earnings, TEVA stock is positioned extremely well for the future.
The world’s population, especially in the Western hemisphere, is growing older. So, then, the need for drugs and medical insurance is rising, including government-sponsored insurance. The latter, in particular, means stronger demand for cheaper drugs, or generics.
TEVA’s management is well aware of that process. It has worked its way through massive mergers, including the latest takeover of Allergan’s (AGN) generic unit. That will increase its capacity for manufacturing generic drugs and allow them to take an even bigger bite of that market.
TEVA stock’s current price-earnings ratio is on the high side at 30, but that is not reflective of all the mergers and acquisitions that took place under the TEVA stock umbrella. TEVA’s forward P/E (currently at 9) takes into account TEVA stock earnings after all acquisitions and mergers are absorbed. Throw in that 2.4% dividend yield and it’s clear TEVA’s future is not priced in and that TEVA stock is worth owning.
Big Pharma Stocks to Buy: Allergan plc Ordinary Shares (AGN)
Why You Should Buy: Strong intrinsic value
When news hit the wires recently that the $160 billion merger between Allergan and Pfizer Inc. (PFE) fell through (which would have saved billions in taxes), AGN stock nosedived to $230 while PFE nudged higher.
On the surface, that might suggest that AGN stock is weak. But, really, that’s just on the surface. Though the merger fell through, Allergan’s management had, in fact, negotiated a very good deal for its shareholders. The fact that PFE stock was slightly higher signals the exact opposite: It was a bad deal for PFE shareholders.
Moreover, when we examine AGN stock earnings, neutralized from the impact of mergers, it’s clear the stock is still a long-term buy. Revenues are growing at 74% year-on-year, and diluted earnings per share on continuing operations (non-GAAP) grew 33% YoY. That is largely thanks to its diverse product offering in therapeutic areas such as gastrointestinal, ophthalmology and aesthetics, such as Botox.
AGN stock is currently trading at $231. As the impact from its cancelled M&A with Pfizer wanes, Allergan’s intrinsic value will come into play and AGN stock will move back higher.
Big Pharma Stocks to Buy: Gilead Sciences, Inc. (GILD)
Why You Should Buy: It’s dirt cheap
Gilead (GILD), unlike some of its peers, is focused on high-margin drugs for infectious diseases such as HIV and Hepatitis C. Those drugs tend to be more expensive than the average drug, hence they tend to be more lucrative. With EPS jumping by 62% YoY and revenue on the rise by 31%, it seems that Gilead’s strategy is working.
Moreover, GILD Stock stands to benefit from the company’s rather lean structure and efficient manufacturing. That enables it to obtain impressive margins, far above peers within the sector. For example, GILD stock’s net profit margin for 2015 was 55%, compared to Pfizer’s 14.25%.
Although GILD Stock is somewhat less diversified than PFE stock, at its current valuation of eight times earnings, it’s practically a bargain.
Big Pharma Stocks to Sell: Pfizer Inc. (PFE)
Why You Should Sell: Lack of focus
Although Pfizer results are relatively stable, it seems that PFE stock lacks focus. The failed $160 billion deal with Allergan only emphasized that. The deal, which contained aggressive tax planning, was badly orchestrated. Those “self-serving” goals (i.e. an aggressive tax saving strategy) were apparently too off-putting for the U.S. Treasury, which put rules in place to disincentivize the two companies from a corporate inversion.
On the revenue front, the picture there is not exactly encouraging, either. PFE revenues have been falling steadily from $54 billion in 2012 to $48 billion in 2015. Earnings are stable, largely from cost cutting, but that’s simply not enough. PFE stock needs to shed weight. In other words, it should cull the less lucrative segments and start generating more revenue growth. While there is no doubt that PFE is not under any threat to its survival, it’s still a slow moving giant that is adrift.
For PFE stock to turn into a buy, it needs new management that could navigate better, or for the price to fall way below its fair value. Until either of those happens, it’s best to avoid PFE stock.
Big Pharma Stocks to Sell: Merck & Co., Inc. (MRK)
Why You Should Sell: The patent cliff looms
Merck & Co. (MRK) growth is under threat. First and foremost, there is the “patent cliff.” Merck, like many other companies, tends to rely on the protection of its patents to guarantee growth. Of course, when those patents expire and cheaper generic substitutes emerge, the revenues from the specific drug tend to fall. And MRK stock has several drugs that are set to expire, hence the cliff analogy.
One high grossing drug patent that is set to expire within the next two years is Zetia, a cholesterol lowering drug with roughly $2.5 billion in annual sales. Other patent expiring drugs include Invanz, Cubicin and Asmanex, though their sales were not disclosed.
But the patent cliff is not the only risk for MRK — its top-selling drug, Januvia, a drug for diabetes patients with annual sales of $3.8 billion, faces intense competition. According to the New York Times, Eli Lilly and Co’s (LLY) competitor drug, Jardiance, was found not only to help diabetes patients but also has a cardiovascular benefit, reducing cardiovascular deaths by 38%. Merck’s Januvia is not known to have such a benefit.
All the while, new drugs in Merck’s pipeline, while promising, have yet to be marketed and sold to validate their potential.
Given the potential decline in sales of top grossing drugs due to patent expiry, the threat to Januvia from an arguably more beneficial competitor, and new yet unproven (revenue-wise) pipeline drugs, MRK stock is one to avoid, for now.
Once Merck gets past this choppiness and overcomes the hurdles, it will be worth another look.
Big Pharma Stocks to Sell: Eli Lilly and Co (LLY)
Why You Should Sell: Risk outweighs growth
Eli Lilly is a stock with potential that has yet to turn into tangible results. Until it does, it’s too risky.
Since 2011, LLY stock has seen its revenues nosedive as many of the company’s drug patents expired (just like the hurdles MRK stock is now facing). Among the biggest hope for LLY stock to recover is Solanezumab, a drug to treat Alzheimer’s disease that is at Phase-III of development.
While this drug carries a lot of growth potential for the company, it is highly risky. Alzheimer’s drugs are known to have a high failure ratio, and despite its advanced stage in clinical testing, its risk for failure remains high.
Other growth drivers are two drugs called Cyramza and Portrazza, both of which are used to treat cancer. Like Solanezumab, both drugs are at the advanced stages in clinical testing, yet neither has generated any tangible revenue.
Another big potential for growth is the drug, Jardiance, which competes head-to-head with Januvia and seems far superior with its cardiovascular benefits.
Don’t be mistaken — the news isn’t all bad. LLY stock does have an impressive pipeline of drugs coming out in the not too distant future. Those drugs, however, do still need to turn into actual revenue. What we are left with is what LLY stock has at present: falling revenues over the past five years, stagnant per-share earnings since 2014 (40% lower than five years ago) and a high P/E multiple of 33.
With all that in mind, it’s better to avoid Eli Lilly stock for now and wait for the drugs in development to hit the market.
As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.