2 Drug Companies to Buy and 1 to Sell

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

Drug companies need to consistently develop their product lines in order to fend off competition, much of which is generated from generic drugs. These firms are constantly setting their sights on the next development, so they can develop a patent and help ensure they create an economic moat. That isn't easy, however, as patents expire and these firms need to innovate once again.

Two of these three firms are doing just that.

Sanofi has eyes on future

Sanofi SA (NYSE: SNY) will likely continue to pour money into research and development, as much of its revenue generates strong cash flow. As the chart below shows, the company's research and development budget is fairly synchronized with revenue growth, due to the firm's ability to transfer that revenue into cash for investing in R&D. When revenue growth increases, it isn't long before the company uses that money for R&D. That's a positive sign for the future, as the firm is committed to growth through product development.

<img alt="" src="http://media.ycharts.com/charts/90acdbf73f26eaa9b907e8cf8425410c.png" />

SNY R&D Expense TTM data by YCharts

The company will need that growth, due to recent patent losses with cancer treatment drugs Taxotere and Eloxatin. However, investors shouldn't worry about these losses, because the company has such a wide portfolio of drugs. Lantus, is one of the better performing drugs that provides the company with likely upcoming gains. The insulin is unlike competitors because it is able to last for an entire day.

The wide portfolio of drugs is bound to have both hits and misses, and analysts see the firm as releasing more popular drugs. Revenue is expected to increase by 4.2% this year and 5.1% next year. However, EPS is pegged to drop 13% this year before rising 13.5% next year.

Gilead's new drug on the pipeline

Gilead Sciences (NASDAQ: GILD) is set to make a massive amount of money off of its hepatitis C drugs, which are in their late stages of development. The aging baby boom is expected to generate $20 billion per year in drug revenue by 2023, according to a Morningstar analyst. However, this market only presents an opportunity for growth over the next 10 years, as there are better blood screening methods that are preventing the onset of hepatitis C. For the time being, Gilead will profit from those who need treatment for existing or undiagnosed hepatitis C.

One of the company's most-anticipated drugs is set to release next year. Now could be the ideal time to buy shares, before the price increases substantially after heightened profits. The drug is expected to be groundbreaking, as it improves hepatitis C treatment from 12 pills per day, to one pill per day.

Analysts also have high hopes for the drug, but there won't be an effect on this year's Earnings Per Share (EPS) when it is only expected to rise 0.5%. However, next year EPS is anticipated to rocket by 52.5%. Despite the stock rising by around 200% in the last two years, a drug with this kind of promise means the increase could just be the beginning.

AbbVie faces too much competition from generic drugs

AbbVie (NYSE: ABBV) faces a major problem due to people opting for generic drugs since the expiration of patents opens the door to those cheaper versions. Sales of Tricor and Trillipix has fallen steadily in the last couple years, and took a nosedive in the second quarter by 50% from the previous period a year ago. That represents a major shift to the company's flagship drugs, and one that should be a major concern for investors. 

The drop in sales wouldn't be much of a concern if AbbVie had a drug with which to replace the other two. But it currently does not appear to have anything major on the pipeline, and that should be a major concern for investors. Furthermore, its other major drug, which generated about $911 million last year, is also facing competition from the generic category, and that will continue to eat into profits.

Analysts are also concerned, but I see their estimates as being optimistic, as the company will need to create a new popular drug to put onto the market. EPS is expected to fall by 7% this year, and gain 3% next year.

Innovation is key

Drug companies are among the riskiest investments, so it is a good idea to invest in the large-cap versions. However, not every one of these three will help you realize gains. That's why it is important to research when new drugs are going to be released, and see what kind of economic moat they carry, and for how long. Otherwise, you could get burned by investing in a company such as AbbVie, which is sure to plunge in the years ahead.

Phillip Woolgar has no position in any stocks mentioned. The Motley Fool recommends Gilead Sciences. 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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