Don't Let Your Attention Defect

Callum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Ineffective drugs being sold for billions in global sales. According to an article in the Wall Street Journal, a study in Quebec on 4,000 students (gathering data for each student over an average of 11 years) showed that boys who had Attention Deficit Hyperactivity Disorder, or ADHD, who took ADHD medication actually did worse than other kids with similar symptoms who didn't take medication. For girls with ADHD, they reported more emotional problems than those with ADHD who didn't take medication.

This news doesn't bode well for Novartis (NYSE: NVS), which sells Ritalin to treat ADHD and ADD and had $554 million in sales with 1% revenue growth in 2012. If Ritalin is shown not to be effective, then there will be a strong drag on Novartis' top line which could constrict growth prospects for the next few years.

While Novartis did have $56.67 billion in sales in 2012, for a company expected to grow that to only $57.2 billion in 2013 a sharp drop in Ritalin sales could slow growth to a standstill (from 1% growth). Novartis is expected to grow its EPS by 5-7% in 2013 which could compensate for the lack of top line growth, but ultimately you need top line growth to grow the company.

Smaller players with bigger stakes

Shire (NASDAQ: SHPG) is a pharmaceutical company with 2012 sales of $4.68 billion. $1.78 billion of those sales came from drugs that treat ADHD, which are Vyvanse, Adderall XR, Intuniv, and Equasym. Vyvanse had 2012 sales of $1.03 billion and is by far its biggest drug. If this study is true and those drugs aren't as effective as people think they are, then Shire could be in for a rude awakening.

Due to generic competition from the likes of Teva, profits at Shire fell from $865 million in 2011 to $745 million in 2012. Shire, by far, will get hit the hardest if this study turns out to be correct.

Now I'm not saying I'm a doctor and that I have all the answers, all I'm saying is that as investors we have to watch out for big changes if the perception of efficacy in the pharmaceutical world. Maybe the Quebec study is wrong and Shire will keep on chugging by, or maybe not.

The study also estimated that 15-20% of all ADHD drugs sold are used by those without a prescription - patients are selling them or giving the drugs away. When I was in school I saw plenty of this happen, and I personally would estimate that number to be higher, but the point is still the same. If parents crack down on their kids selling or giving their medication away then sales will definitely get hit, regardless of how effective those drugs are.

Not good enough

Shire has plenty of headwinds ahead of it for its second best selling drug, Adderall XR. Adderall XR sales were down 19% in 2012 due to generic competition to $429 million. On the plus side, sales of Shire's best selling drug Vyvanse were up 15% in its latest quarter to $298 million. An investment in Shire is largely banking on the continued success of Vyvanse which can compensate for the drop off in Adderall XR sales.

Shire also has seen strong growth in Lialda/Mezavant (up 12% to $101 million), Vpriv (up 14% to $82 million), Intuniv (up 13% to $78 million) and Firazyr (up 112% to $42 million). Sales of some of its other drugs were pretty disappointing but growth from Vyvanse balanced out the quarter.

I wouldn't recommend investing in Shire because even if it has a good drug like Vyvanse (which treats ADHD), the drop in sales from Adderall XR and other drugs still caused Shire to post only a 1% revenue gain in the first quarter. Additionally, if you factor in the study, if these drugs turn out to be not as effective as previously thought then Shire is in for a sharp drop. Shire also pays out a small 0.9% dividend, and there simply are better pharma stocks to invest in that pay out much bigger dividends and offer safer growth.

Big, slow, and profitable

Novartis is a huge pharma company that pays out a 3.6% dividend. At a PE of 18.3, with little to no revenue growth and 5-7% EPS growth, Novartis is currently overvalued. If it was a little cheaper then it would be worth looking into as a dividend play, but at this price it simply is too expensive. It offers little capital gains and a dividend which is smaller than its peers.

Novartis has only a little exposure to the ADHD sector, so they won't get really hurt if the study turns out to be true, but they need more top line growth going forward. I would recommend Novartis over Shire, but there are better pharma stocks out there than both of those companies.

Another way

ADHD drugs are also sometimes used to treat narcolepsy, but Jazz Pharmaceuticals (NASDAQ: JAZZ) has found a better way to treat narcolepsy with its blockbuster drug Xyrem. Xyrem competes with drugs like Prozac, and works much better than using amphetamines to keep patients awake if they suffer from narcolepsy.

Xyrem sales have been very strong, with sales rising from $220 million in 2011 to almost $400 million in 2012. In the first quarter of 2013, Xyrem sales were up 60% year over year. Jazz also sells the drug Erwinaze, which has exclusivity in the U.S. until 2018 with orphan drug status. Erwinaze showed sales growth of 27.1% in the first quarter year over year.

Jazz trades at a PE of 16.1 and is expected to grow its EPS by 16-17% over the next several years. With strong sales growth and continuous upward guidance revisions, like the revision for 2013 earnings to be $6.10 - $6.30 from $5.70 - $5.90, Jazz looks like a solid growth story over the next few years. Bullish on Jazz.

Final thoughts

I'm not saying that the Quebec study that the Wall Street Journal brought up is correct or that I'm an expert. What I am saying is that Shire is heavily exposed to the ADHD market and that if the study turns out to be right, combined with increased generic competition for one of its best selling drugs, Shire's stock will get hammered. Not to mention that it is estimated that 15-20% of all ADHD drugs sold are used by those without a prescription (according to the study). If parents crack down on their kids selling their medication then sales will definitely get hit.

For Novartis, it simply isn't growing fast enough for my liking, and I wouldn't recommend it. Even with a forward PE of 13, there are better dividend plays out there (look for stocks yielding over 4%) that are going to grow faster and pay out more money. Jazz Pharmaceuticals has a long growth runaway ahead of it, and is worth taking a look at if you want a nice pharma growth play with a company that has a $4 billion market cap.

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