Strong Generic Drug Makers Should Thrive
By JOHANNA BENNETT
BY BUYING Eon Labs and Hexal AG, European drug giant Novartis has rekindled investors' interest in generic drug manufacturers and buttressed speculation that the beleaguered, fragmented industry will consolidate.
In hopes of finding the next takeover target, investors bid up shares of Impax Laboratories, Ivax, Watson Pharmaceutical and Andrx Group earlier this week.
Nevertheless, because profit-sapping pricing wars still plague the industry, some pros suggest that investors not just look for the next big deal but seek out strong companies that will do well on their own.
"If you try and play the rumors, you will probably be too late to profit. You could also be dead wrong," warns Steve Lampe, a portfolio manager with Delaware Investment Advisors.
"We are much more comfortable picking names that we fundamentally like. If they have the potential to be taken out at a valuation north of where they trade, then all the better," adds David Heupel, manager of the Thrivent Large Cap Growth Fund.
At a Glance: Ivax (IVX)
Stock Price: $15.87
52-Wk High: $20.91
52-Wk Low: $12.36
Market Cap: $3.9billion
Earnings Est. (2005): $0.83
Forward P/E: 19.1x
Projected Long-term EPS Growth Rate: 25%
Projected EPS Growth ('05/'04): 15%
Sales (2003): $1.4 billion
Div. Yield: None
CEO: Phillip Frost M.D.
Headquarters: Miami, Fla.
Sources: Thomson First Call; Yahoo! Finance; company data
Several factors are behind generic drug makers' growing popularity: expiring drug patents, the demand for cheaper alternatives to branded medications and the 2006 launch of a prescription drug benefit covering 40 million Medicare recipients.
Generic drug sales should jump more than 20% annually over the next few years reaching $80 billion by 2008, growing more than twice as fast as branded drug sales, according to IMS Health.
"This is the way the world is going. It is all about controlling costs and the quality of health care," says Les Funtleyder, a health care strategist at Miller Tabak & Co., an institutional trading firm.
Next year alone, drugs with annual sales of $16 billion should come off patent, including Merck's Zocor and Pfizer's Zoloft.
That's in addition to the $51 billion in annual sales of drugs whose patents expired between 2001 and 2005, according to IMS.
That could mean lots of opportunities for companies like Miami-based Ivax, known for making generic drugs that treat schizophrenia and asthma.
With profits that are expected to grow 15% this year, it "is one of a very few generic and specialty pharmaceutical firms that should deliver above-average earnings growth in 2005," says David Woodburn, an analyst with Prudential Equity Group.
The stock tanked in early November, hitting a 52-week low when heightened competition led to a shortfall in quarterly profits and revenues.
But margins should improve as the company cuts costs and as higher-profit branded drugs developed by Ivax or in partnership with other companies generate a bigger chunk of revenues, says Miller Tabak's Funtleyder.
Ivax has 61 applications for new generic drugs pending before the U.S. Food and Drug Administration. Twelve of them could get "first to file" status, which would grant Ivax exclusive rights to market the drug for six months.
A generic version of GlaxoSmithKline's allergy nasal spray Flonase should go on sale in the next six months, as should an environmentally friendly asthma inhaler.
Ivax faces limited competition from producers of competing drugs, because it is one of only a handful of manufacturers that can produce either one.
Meanwhile, a deal with Pfizer will let Ivax manufacture an "authorized generic" version of the heart medication Zoloft when the patent expires in 2006. Also, Ivax and European biotechnology giant Serono are developing an oral multiple sclerosis drug.
"They have a pipeline that a lot of branded drug companies would love to have," says Funtleyder.
At Thursday's close of 15.87, the stock trades 24% off its 52-week high from last September (see At a Glance).
Selling at 19.1x projected profits over the next four quarters, Ivax's stock trades at a slight discount to its median P/E multiple over the last five years, according to Thomson Baseline.
But since profits are expected to grow 25% annually over the next five years, Ivax's price-to-earnings growth (PEG) ratio of 0.76 looks attractive.
Another potential winner: Impax Laboratories, which launched a generic version of GlaxoSmithKline's Wellbutrin SR depression drug in 200-milligram tablets and should market another four to five new drugs this year.
As the first to file an application with the FDA for Wellbutrin SR 200 mg., Impax has six months of market exclusivity. And because it launched the drug without a partner, gross margins should improve this year, says David Maris, an analyst with Banc of America Securities.
Unprofitable until last year, Impax should report earnings of 92 cents a share in 2005, up 268% from 2004, according to First Call.
Yet the stock still trades 34% below its 52-week high (see At a Glance).
At 18.4x forward earnings, it's also well below its five-year median of 32x forward earnings, according to Baseline.
Neither Impax nor Ivax can afford to delay new drug launches, miss earnings or lose patent lawsuits.
Also a no-no: Any unpopular acquisition resembling last year's brouhaha over Mylan Laboratories buying King Pharmaceuticals.
But generic drug makers whose margins are improving and that have promising new products with little competition can easily let any merger parade in their industry pass them by -- and still get investors to take notice. |
