Consider This Pharma On Strong Earnings Prospects

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Many big drug companies are scrambling to compensate as key patents expire, exposing previously protected drugs to generic competition. Investors should be careful to only buy pharmaceutical companies at valuations that are attractive given their earnings prospects.

Financial Metrics

Consider the following:

<table> <tbody> <tr> <td> <p><strong><span>Ticker</span></strong></p> </td> <td> <p><strong><span>Company</span></strong></p> </td> <td> <p><strong><span>Country</span></strong></p> </td> <td> <p><strong><span>P/E</span></strong></p> </td> <td> <p><strong><span>P/S</span></strong></p> </td> <td> <p><strong><span>P/</span><span>FCF</span></strong></p> </td> <td> <p><strong><span>EPS growth next 5 years</span></strong></p> </td> </tr> <tr> <td> <p><span>LLY</span></p> </td> <td> <p><span>Eli Lilly</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>14.01</span></p> </td> <td> <p><span>2.64</span></p> </td> <td> <p><span>27.21</span></p> </td> <td> <p><span>-4.71%</span></p> </td> </tr> <tr> <td> <p><span>AZN</span></p> </td> <td> <p><span>AstraZeneca</span></p> </td> <td> <p><span>UK</span></p> </td> <td> <p><span>9.83</span></p> </td> <td> <p><span>2.04</span></p> </td> <td> <p><span> </span></p> </td> <td> <p><span>-3.50%</span></p> </td> </tr> <tr> <td> <p><span>PFE</span></p> </td> <td> <p><span>Pfizer</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>20.77</span></p> </td> <td> <p><span>3.15</span></p> </td> <td> <p><span>20.8</span></p> </td> <td> <p><span>2.10%</span></p> </td> </tr> <tr> <td> <p><span>BMY</span></p> </td> <td> <p><span>Bristol-Myers Squibb</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>30.6</span></p> </td> <td> <p><span>2.92</span></p> </td> <td> <p><span>11.28</span></p> </td> <td> <p><span>2.59%</span></p> </td> </tr> <tr> <td> <p><span>SNY</span></p> </td> <td> <p><span>Sanofi</span></p> </td> <td> <p><span>France</span></p> </td> <td> <p><span>16.06</span></p> </td> <td> <p><span>2.66</span></p> </td> <td> <p><span> </span></p> </td> <td> <p><span>2.60%</span></p> </td> </tr> <tr> <td> <p><span>NVS</span></p> </td> <td> <p><span>Novartis</span></p> </td> <td> <p><span>Switzerland</span></p> </td> <td> <p><span>18.16</span></p> </td> <td> <p><span>3.03</span></p> </td> <td> <p><span>31.67</span></p> </td> <td> <p><span>2.98%</span></p> </td> </tr> <tr> <td> <p><span>MRK</span></p> </td> <td> <p><span>Merck</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>19.08</span></p> </td> <td> <p><span>2.67</span></p> </td> <td> <p><span>27.34</span></p> </td> <td> <p><span>3.63%</span></p> </td> </tr> <tr> <td> <p><span>GSK</span></p> </td> <td> <p><span>GlaxoSmithKline</span></p> </td> <td> <p><span>UK</span></p> </td> <td> <p><span>13.79</span></p> </td> <td> <p><span>2.52</span></p> </td> <td> <p><span> </span></p> </td> <td> <p><span>6.23%</span></p> </td> </tr> <tr> <td> <p><span>JNJ</span></p> </td> <td> <p><span>Johnson & Johnson</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>23.54</span></p> </td> <td> <p><span>3.01</span></p> </td> <td> <p><span>32.6</span></p> </td> <td> <p><span>6.41%</span></p> </td> </tr> <tr> <td> <p><span>ABT</span></p> </td> <td> <p><span>Abbott Laboratories</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>8.05</span></p> </td> <td> <p><span>1.33</span></p> </td> <td> <p><span>11.86</span></p> </td> <td> <p><span>8.48%</span></p> </td> </tr> <tr> <td> <p><span>TEVA</span></p> </td> <td> <p><span>Teva Pharmaceuticals</span></p> </td> <td> <p><span>Israel</span></p> </td> <td> <p><span>15.59</span></p> </td> <td> <p><span>1.73</span></p> </td> <td> <p><span>14.37</span></p> </td> <td> <p><span>8.91%</span></p> </td> </tr> <tr> <td> <p><span>AGN</span></p> </td> <td> <p><span>Allergan</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>28.62</span></p> </td> <td> <p><span>5.28</span></p> </td> <td> <p><span>23.82</span></p> </td> <td> <p><span>12.53%</span></p> </td> </tr> <tr> <td> <p><span>NVO</span></p> </td> <td> <p><span>Novo Nordisk</span></p> </td> <td> <p><span>Denmark</span></p> </td> <td> <p><span>25.6</span></p> </td> <td> <p><span>5.65</span></p> </td> <td> <p><span>32.26</span></p> </td> <td> <p><span>17.95%</span></p> </td> </tr> </tbody> </table>

Data from Finviz.com

Analysts expect declining earnings for Eli Lilly (LLY) and AstraZeneca (AZN) over the next five years. Earnings growth should not be assumed as given for these companies.

Instead, investors should be looking to companies with attractive valuations given analyst expectations. Investors should also try to avoid companies which are likely to make acquisitions since their share prices tend to plunge once a takeover is announced.

Teva Focuses Drug Development Pipeline

Teva Pharmaceuticals (NYSE: TEVA) isn’t trying to grow by acquiring diverse projects and business units. Instead, it plans to focus on developing drugs for respiratory and central nervous system illnesses. This change in strategy was proposed by the firm’s new Chief Executive Officer Jeremy Levin and will involve ending five research programs in various stages of development and plan to cut costs of about $2 billion for the company in the next five years.

Teva’s Chief Executive Officer Jeremy Levin said, “We are interested in building fundamental capabilities because we know where we are going now. Teva must focus on organic growth. In doing that, our focus has to be on transactions that either extend our geography, extend dramatically our pipeline or, in fact, secure a product or a product line that increases one of our franchises.”

Mr. Levin, the former Bristol-Myers Squibb (BMY) Senior Vice President for strategy who joined Teva in May, thinks that Teva -- which has grown to become the world’s biggest generic-drug maker through 25 acquisitions in the past decade -- has become more complex and developed unfocused pipeline inherited from its acquisitions. The new CEO intends to shift strategy from growth through acquisitions to increased reliance on organic development through research and licensing agreements with partners.

With its best-selling drug Copaxone, an injection for multiple-sclerosis, losing its exclusivity in 2015, investors are skeptical if Teva can sustain its growth. Goldman Sachs analyst Jami Rubin wrote, “We do not see a pipeline drug with enough innovation to replace Copaxone. More importantly, we would have liked to see a greater commitment to rewarding investors with additional cash returns.” Analysts reduced price estimates and downgraded the outlook for the stock, citing Teva will have to go through a lengthy transition process and planned cost-cutting measures will have delayed impact on the company’s prospects. Another branded drug, Treanda – a treatment for chronic lymphocytic leukemia will also lose U.S. patent protection in 2015.

On queries relative to the experimental cancer drug CT-011, Teva’s Chief Scientific Officer Michael Hayden explained, “We are doing the proper diligence to assess the potential of the drug. We haven’t made a decision yet.” Levin and Hayden also disclosed plans to extend patent protection for Copaxone until 2030 by developing a thrice-a-week variant or by combining Copaxone with Laquinimod, another experimental drug.

Aside from respiratory and central nervous system drugs, Teva will likewise concentrate on “high-value” generic drugs and existing medicines that are formulated in a different way, in an effort to sustain earnings amidst slow-down for the generic-drug business. Last May, Teva cut its 2012 revenue forecast citing increased competition plus increasing cost in generics and slower economic growth.

The five research projects due for termination include StemEx, a technology expanding umbilical stem cells for use in cord blood transplants to patients with leukemia and lymphoma; Obatoclax for lung cancer; MultiGeneAngio for peripheral arterial disease; lower-volume Copaxone dosage for reduced injection discomfort; and PolyHeal and NexoBrid for wound care.

Teva is searching for collaboration relating to a Type 1 diabetes treatment, currently under development with Andromeda Biotech, a unit of Clal Biotechnology Industries (CBI). As part of Teva’s new thrust, it will continue to dispose of “non-core” products unrelated to its central focus, proceed with disciplined acquisitions of small and mid-sized firms for the next five years, and stick to licensing deals with suitable partners.

Relative to its commitment to enhance shareholder returns, there will be share buybacks along with earmarking 20% to 25% of its operational cash flow for shareholder dividends.

Abbott, J&J, Sanofi Said to Show Bausch & Lomb Interest

On the other hand, Abbott Laboratories (NYSE: ABT), Sanofi (NYSE: SNY), and Johnson & Johnson (NYSE: JNJ) have been reported has being interested in acquiring Bausch & Lomb. This eye-care company is being sold by Warburg Pincus according undisclosed sources.

Warburg is said to have hired Goldman Sachs (GS), and is making the company’s financial information available to the prospective buyers. It expects initial bids to stream in by end of January. Warburg intends to collect close to $10 billion from the sale of Bausch & Lomb, a handsome profit for Warburg who invested almost $2 billion in Bausch & Lomb.

Abbott Laboratories has partnered with Morgan Stanley (MS) as its lead financial adviser in the purchase of Bausch & Lomb according to unnamed sources. The other prospective buyer, Sanofi, has sought the services of Evercore Partners (EVR) as its adviser. However none of the representatives from the prospective buyers or the seller were willing to comment on the deal at hand. There are other potential suitors who could also be interested in the purchase of Bausch & Lomb including Pfizer and Merck.

Undisclosed sources said that Bausch & Lomb is structured into three different business units namely: pharmaceuticals, vision care, and surgical. Warburg intends to sell all of Bausch & Lomb mainly because a split would lead to tax complications.

Conclusion

Based on recent news, Teva looks like an interesting buy candidate. It is cheap for a company with its expected earnings growth, and it does not seem to be interested in chasing acquisitions.

Investors interested in Abbott should wait until an acquisition is announced and its share price drops. Buying prior to such an event is irrational in the face of a price drop. Yes, it trades at a low earnings multiple, but it appears to have an appetite for acquisitions. Investors should wait to buy at lower, post-acquisition announcement share prices.


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