How Will the Patent Cliff Affect These Pharmaceuticals?

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The pharmaceutical sector is mainly about the pipeline of new products and patents. The term patent cliff is being used to describe drugs that are near their patent expiration date which is extremely important because after the expiry new generic producers invade the market generating sales and price cuts for those specific drugs. Also, the pipeline of new product development has not been as successful as decades before and this has put pressure on some pharmaceutical companies. However, these issues are not equally affecting all of the drug manufacturers.

Let’s take a look at Abbott (NYSE: ABT), Pfizer (NYSE: PFE) and Merck (NYSE: MRK) to see their situation in this tough market environment.

Abbot: A solid stock at bargain

Abbott operates in diverse segments internationally, including its nutrition, diagnostics, pharmaceuticals and medical device businesses. The company posted net sales for the first quarter of 2013 of $5.4 billion which meant an increase of 1.8% compared to the same quarter the prior year. However, Abbott showed a decrease in net earnings of more than 56% to $544 million for the same period of comparison. The company is exposed to emerging markets as they account for more than 40% of total sales. These markets gave good results this quarter as sales amounted to $2.2 billion increasing 15.2% on an operational basis compared to the same quarter of 2012.

The interesting point about this company is that it continued to deliver good results although its pharmaceutical business sales declined 1.9% in the first quarter of 2013 compared to the same quarter the prior year. A reason for this can be its diversified revenue mix comprised by: 31.6% nutrition, 24.7% medical devices, 23% pharmaceuticals and 20.2% diagnostics.

This company has excellent growth prospects as it has launched new products and initiated new trials in this first quarter. Abbott’s stock price has surged almost 15% in the past year. And given the reaffirmed EPS guidance of $2.02 for 2013, expect some more.

Pfizer: Future growth prospects look good

Pfizer manufactures a diverse product portfolio that includes human and animal biologic and small molecule medicines and vaccines, as well as nutritional products. Pfizer posted $13.5 billion in revenue for the first quarter of 2013, a 9% decrease compared to the same quarter of 2012. But due to a decline in selling, informational and administrative expenses (10%) as well as cost of sales (2%) and research and development expenses (3%), the company reported a net income of $2.75 billion or 53% more than in the first quarter of 2012. But Pfizer will have to deal with some alarming drops in its most important units’ revenue: primary care (20% drop), specialty care (6%) and established products (15%). The company will also have to face another problem as the European patent of one of its leading drugs, Viagra, expired. That drug generated more than $2 billion in revenue for 2012. 

Pfizer has benefited from the Zoetis’ IPO in which the company had a 19.8% interest and saw $6 billion in proceeds. Although Pfizer’s stock price declined after the IPO, it has gained more than 23% from June to the present date. However, it is expected that Pfizer will spin off its remaining ~80% interest in Zoetis, which could impact short term EPS and be accretive post 2014. Investors should acquire Pfizer shares only if they have a long-term horizon. 

Merck: Suffering from the patent cliff

Merck produces prescription medicines, vaccines, biologic therapies, and consumer care and animal health products. It is present in 140 countries. The company is having revenue problems amid the patent cliff affecting most of the pharmaceutical companies: as Mr. Kenneth Frazier, chairman and CEO, stated “Our first quarter performance reflects the challenges of major patent expiries coupled with the impact of currency and other headwinds.”

Merck lost market exclusivity of several drugs: Singulair, Maxalt and Clarinex. This is a huge problem as the pharmaceutical segment accounts for more than 83% of total sales. Merck has posted a sales figure of $10.7 billion for the first quarter of 2013, a 9% decline compared to the same quarter in 2012 and a 24% decrease in net income totaling $992 million for the same period of comparison.

Although the company’s stock has not suffered major setbacks as it gained 16.2% in the past year, Merck has a lot of problems ahead to solve. One solution for Merck's growth forecast could be growing by acquiring another smaller player. The company already estimates $5 billion to be used in acquisition related costs for 2013. 

Final comment

Abbot presents a very good opportunity to get more exposure to the pharmaceutical business because although it has the lowest P/E of the peer group at 17.3, it also has the lowest PEG ratio at .9 (all of the three companies have similar dividend yields around 3.3% to 3.7%) which could indicate the stock is undervalued; compared to a higher PEG ratio for Pfizer at 3.9 and Merck's higher PE of 24.1.

Moreover, Abbott has the greatest return on equity at 21.9% and the biggest return on assets,10%, of this group. Pfizer is a long-term investment as the possible Zoetis divestment will be accretive post 2014 and current results are not encouraging. Merck, on the other hand, is the most overvalued company in the peer group, and appears to be the least attractive option.

Fernando Domenici has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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